When a new owner takes over, change comes with the territory
|When the phones go silent, a rift often occurs between franchisee and franchisor.|
In 2000, Tim and Janice Charrier of Kenner, Louisiana, were among the first 20 franchisees of Outdoor Lighting Perspectives, a franchisor of landscape lighting systems founded by Tom Fenig in Matthews, North Carolina. After recovering from Hurricane Katrina, the Charriers renewed their five-year contract in 2006. In September 2008, Fenig notified them he had sold his 75-unit system to Outdoor Living Brands, the franchisor of Archadeck, in Richmond, Virginia.
“Things were thrown upon us,” said Tim Charrier. “We had signed our renewal expecting ‘x, y and z’ and now we were getting ‘a, b and c.’” David Perlmutter, who had purchased an existing Outdoor Lighting Perspectives franchise in Pittsburgh, Pennsylvania, in 2007, said, “Tom Fenig cared about us and often telephoned. When he asked about our closing sales for the month, it was like telling Dad what’s going on.”
Franchisees around the country are losing “Dad” at a rapid rate, and more franchise sales are anticipated. In the past few months private equity funds purchased Lawn Doctor, Veggie Grill, Chem-Dry, C2 Education Centers and J.D. Byrider; Tasti D-Lite bought Planet Smoothie and Dessange International snapped up Fantastic Sam’s.
Kevin Hein, who heads the franchise practice of Faegre Baker Daniels in Denver and Ted Pearce, senior vice president and general counsel for Driven Brands in Charlotte, North Carolina, co-authored a chapter on mergers and acquisitions in franchise systems for the new “Franchise Law Compliance Manual,” available from the American Bar Association. In it, they say the era of “organic growth” is over for most franchise systems as “growth through acquisition or consolidation becomes the norm.”
As Carrier and Perlmutter learned, most of these acquisitions come as a complete surprise to franchisees. “When you are buying a franchise system,” said Hein, “you are buying the value of the franchise contracts.” The seller wants complete secrecy because any kind of disclosure “may cause great commotion and anxieties within the franchise system” and lower its value. Potential buyers sign confidentiality agreements before quietly performing weeks, or even months, of due diligence.
Outdoor Living Brands CEO Christopher Grandpre said he hired an outside party to make blind validation calls to all Outdoor Lighting Perspectives franchisees “to gauge their level of enthusiasm and optimism. We wanted to purchase a known quantity.” Grandpre finalized that purchase on September 30, 2008. A week later the stock market crashed and Outdoor Lighting’s customers stopped ordering lights for their gardens.
“Things were never the same,” said Charrier. “We no longer had a personable relationship with our franchisor.” Charrier said the franchisor stopped selling locations, and a number of existing franchisees closed down. By the time they were supposed to renew their contract in 2011, “the system was a skeleton, and we were between a rock and a hard place,” Charrier said. “We could sign up for something we didn’t believe in, or go out on our own and risk legal action.”
The transfer sections of almost all franchise contracts give franchisors the right to sell their companies to anyone they choose, Hein says. The new owner assumes all franchisee contracts, which remain valid until their original expiration dates. Like any owner, the purchaser can make significant changes to the system, which franchisees must accept in order to renew their contracts. If the purchaser is a competitor, as when Atlanta-based HoneyBaked Ham bought rival Heavenly Ham in 2002, franchisees of the combined company may find themselves competing against each other within the same territory. In that situation, HoneyBaked Ham left Heavenly Ham as a separate company, allowing Heavenly Ham franchisees to continue operating, convert to its brand or, in some cases, to be released from their contracts and become independent stores. Most chose conversion, and Heavenly Ham has dropped from 200 units to 13.
The blending of brands is often less harmonious. In the 1990’s when AFC Enterprises—also based in Atlanta—the franchisor of Popeyes Chicken restaurants, acquired the Church’s Chicken chain, several Popeye’s franchisees sued claiming that AFC favored Church’s franchisees by allowing them to infringe on Popeyes territories. The courts, however, ruled that AFC had the right to grant Church’s franchises anywhere, even if they directly competed with Popeyes stores. The franchisor also prevailed when American Capital Strategies, the owner of Cottman Transmissions, purchased AAMCO Transmissions in 2006 and told all Cottman franchisees to switch to the better known AAMCO name. Attorney Justin Klein, of Marks & Klein in Red Bank, New Jersey, says the last holdout, Cottman franchisees, recently reached a settlement with their franchisor.
Franchisees who decide not to renew their contracts with a new franchisor are still subject to noncompete clauses in their old agreements. When Charrier and Perlmutter both elected to not remain with Outdoor Lighting and kept operating as independents, Grandpre filed lawsuits, asking the Circuit Court of Henrico County, Virginia, for preliminary injunctions to shut them down. In the only case to reach court so far, a judge ruled against Charrier.
In the meantime, Klein has filed a lawsuit against Outdoor Lighting on behalf of Charrier, Perlmutter and four former franchisees, asking they be released from their contracts without penalty because “the system is failing,” and Grandpre has sold no new franchises and provided no new marketing programs or products.
Grandpre denies the allegations, saying he has diversified Outdoor Lighting’s business model, and even purchased a third franchise, Mosquito Squad, that Outdoor Lighting franchisees can add to their businesses. “The real problem is the economy,” he said. “The (Outdoor Lighting) franchisees and I had a very short honeymoon.”
New York attorney Richard Rosen, says such lawsuits generally turn, not on such allegations, but “on an analysis of the specific terms of the parties’ franchise agreement.” Acquired franchisees often claim, he said, that the new owner has breached “the implied covenant of good faith and fair dealing” in their contracts.
A covenant breach is one of the many complaints in the Black Donuts lawsuit filed by 18 California tire dealers against their franchisor Big O Tires, of Juno Beach, Florida. In that lawsuit, Big O franchisees claim their troubles began in 2005, when their franchisor was purchased by a subsidiary of a Japanese conglomerate that owns hundreds of corporate tire stores. The new owners, franchisees say, talked them into a tire purchase plan that increased their royalties from 2 percent to 6 percent, and forced them to purchase new computer systems that “corporate stores can tap into.” Big O has stopped selling new franchises, the complaint alleges, and allows corporate stores to undercut franchisees on price.
The franchisees’ attorney, Nick Hornberger, of Hornberger and Brewer in Los Angeles, said his clients are seeking damages, attorney costs and rescission of their contracts. No trial date has not been set and Big O’s attorney did not return phone calls by press time.
Most franchise acquisitions, of course, turn out just fine. Private equity firms are able to inject needed capital into the systems they purchase, Hein says, and franchisors purchased by companies with complementary products or services can become strong partners. Batteries Plus, in Hartland, Wisconsin, has grown from 300 to over 500 units since being purchased by Roark Capital of Atlanta in 2007, said CEO Russ Reynolds. “Roark has given us more value,” said franchisee Dustin Myers in Lancaster, Pennsylvania, “by helping us add light bulbs to the products we sell.”
Chicago attorney Carmen Caruso said franchisees can avoid being “blindsided” by the sale of their franchise by staying alert to changes in their franchisor’s status. Warning signs include: frequent restructuring of the franchisor’s debt, changes in key vendors, departures of key employees and demands for unrealistic growth. “If they don’t have one,” Caruso said, “this is the time franchisees should form an independent franchisee association to help them set a unified strategy.”
Acquiring organizations can avoid conflict, Hein and Pearce say in their book chapter, with thorough due diligence on the franchisee community. Once the sale has closed, the attorneys recommend the purchaser inform the franchisee association first. Then it can establish a toll-free phone number, or tell all franchisees how the acquisition might affect them via a prerecorded phone call, or video message on a web site. “With many franchise sales,” they write, “franchisees may become fearful or anxious simply because they do not know what is happening. Once they are informed, understand the reasons for the transaction and know what will happen to them and the system in the future, they will go back to business as usual.”
Perlmutter said, “We were excited when we heard that Outdoor Lighting Perspectives had been sold, because we thought we would grow more with a larger company. But then we didn’t hear from anyone at corporate for a long time. If Chris Grandpre had called a meeting...a lot of this could have been fixed and the franchise system would still be running smoothly.”