By: Dennis L. Monroe
Krass Monroe P.A.
In the present fluid and volatile franchise world, it is imperative that a franchise system knows itself. As I have discovered in my representation of many franchisors and franchisees, it is rare a franchisor has a good understanding of its franchisees financial positions. It may be that the franchisor understands an individual franchisee or multi-unit operators profit and loss positions and clearly understands whether the franchisee is current on royalties and advertising payments. This is only a small part of the picture. Franchisees are always concerned about franchise rights, so the first thing paid after normal operating expenses is usually the franchisor. Thus, it is very unusual for the franchisor to have an indication of the franchisees financial problems based solely on royalty and advertising payments. If the franchisor does have franchisees that are in default or falling behind in payments to the franchisor, it is probably late in the troubled companys financial scenario.
What further exacerbates this understanding in a potential troubled franchisee situation is the sometimes unhealthy distrust between the franchisor and franchisee. Too often, there is a thought among franchisees that if the franchisor knows too much about their financial position, the franchisor may initiate undue constraints on the franchisee. Oftentimes, the theory that knowledge is power, and less knowledge is better, clouds many franchisees minds.
Given this backdrop, what can franchise systems do to help the system move forward and protect the franchisee business model? Please consider the following ideas:
- Balance Sheet. The biggest problem that exists in the franchise community today is poor balance sheets. Franchise systems should be emphasizing open sharing by the franchisee of their financial information, particularly their balance sheets. In addition to financial information, the franchisee should provide a list of their lenders, their liquidity position and, in general, a description of any key financial problems they may be having.
- Franchisee Questionnaire. We have been developing various questionnaires that can be utilized by the franchisor to facilitate obtaining a good understanding of the franchisees financial position. The questionnaire is not intended to be a heavy-handed approach, but a form for the franchisees to provide basic information. Here is a sampling of the types of information requested in a good questionnaire:
- Name(s) of the lender(s) and type of loan (this does not have to be terribly detailed).
- Franchisees thoughts about development, where they are at with the development process and how the franchisor can help.
- A list of personal guaranties.
- A summary of working capital/liquidity needs (e.g., accounts payable aging).
- A list of outside investors and issues with these investors.
- Recent injections of capital.
The answers to these questions will provide both franchisee and franchisor with a clear understanding of the franchisees financial position.
- Corporate Structure. It is important for the franchisor to understand the overall corporate structure of its franchisees. What types of entities are being used? Have there been Sub-chapter S elections? Have there been conversions to LLCs? What are the buy/sell provisions? What type of insurance is in place?
- Lenders. Information obtained from the franchisee regarding lender issues can provide the franchisor with the opportunity to proactively meet with the lenders, provide intercreditor rights and, in general, provide some breathing room for the franchisee. Further, many franchisors have retained outside workout firms to help with problematic lender situations and even, at times, to assist in the economic cost of these professionals.
- Landlord Positions. Probably the most important element for franchisors to understand is where its franchisees are at with their landlords. Are there current defaults? Are there potential defaults? Are the rent rates above current market and need to be renegotiated? Do the leases have various acceleration rights that may create a problem if there is a default? (Note that assignments of leases and remarketing agreements with lenders can help calm down concerns of landlords.) Again, many franchisors have retained outside professionals to assist franchisees in renegotiating non-market leases.
- Supplier and Current Accounts Payables. Where are the franchisees at with payments to their suppliers? Are they behind? Is there a liquidity crunch? Are there unpaid sales or payroll taxes? I believe if the franchisor is aware of these issues, the franchisor can be of assistance to its franchisees. Franchisor involvement may not be in direct monetary payments but can help provide ways to keep the stores open. An example would be an assurance by the franchisor of the potential payment to a system wide supplier.
Because of the legal nature of the franchise documents, an adversarial relationship sometimes develops between the franchisor and its franchisees. In todays tight economic situation, there really is no room for this approach. Instead, everyone needs to look at the various options and work together in a spirit of trust and cooperation.
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