The Hidden Costs Of Acquiring Another Franchise System
The Hidden Costs Of Acquiring Another Franchise System
The franchisor may want to add or subtract certain items from the acquired franchisor’s (“Newco’s”) system to either allow for additional distribution of the franchisor’s product or to make the systems more similar. Otherwise, the acquiring franchisor may have plans to convert Newco’s system to the franchisor’s system.
As the acquiring franchisor conducts due diligence on Newco, it should review Newco’s existing franchise agreements to determine whether or not language is included that allows the franchisor to add to, subtract from, or alter the existing system at its discretion. The franchisor should also plot the locations of Newco’s franchisees on a map to determine whether any of them are within the trading area of the franchisor’s franchisees.
Although the franchise agreement may allow for an altering of the product mix with Newco’s franchisees, the acquiring franchisor must take in into account its duty of fair dealing in exercising any discretionary powers under the franchise agreements, a duty that is codified in Ontario and Alberta under franchise legislation in the two provinces. If, for example, the franchisor decided to require Newco’s franchisees to stop selling a product that competes with the franchisor’s system and there is no independent reason for doing so other than the elimination of the competitive product for the benefit of the franchisor’s franchisees, the franchisor may be seen to be not acting in good faith. In Gateway Realty Ltd. v Arton Holdings Ltd. and LeHave Developments Ltd, a Nova Scotia court has held that bad faith is:
when one party, without reasonable justification, acts in relation to the contracts in a manner where the results would be to substantially nullify the bargained objective or benefit contracted for by the other, or to cause significant harm to the other, contrary to the original purpose and expectations of the parties.
In the above scenario, there may also be competition law issues if the result of a product removal is to unduly lessen competition.
If the product being replaced was unique to Newco’s franchise system and the removal of the product, would “substantially nullify the bargained objective” of the franchise agreement, then the franchisor should proceed with caution. The practical consequences of introducing new products or re-branding locations is that it may cost the franchisor a significant amount of money to coerce franchisees into making the required changes if the changes would result in a franchise fundamentally different than what the franchisee had originally bargained for.
The franchisor may decide that it will stop promoting the growth of one system over the other. In the Ontario case of Shelanu Inc. v. Print Three Franchising Corp. the court held that there was nothing in the franchise agreements which required the franchisor to maintain a certain level of franchisees. That being said, if the franchisor stops promoting the Newco brand, it may be open to liability for misrepresentations made in marketing materials or other representations made to franchisees with respect to building a certain number of new stores to help support marketing and brand name awareness.
If the franchisor’s goal is a complete re-branding of Newco’s system, the franchisor should have, in advance of the acquisition, mapped out areas of potential conflict that would result in franchisees of both systems competing too closely or encroaching on one another. The leading Canadian case on encroachment is a 1995 Quebec case, Provigo Distribution Inc. c. Supermarche A.R.G. Inc. In that case, the Court found Provigo, the franchisor, to be acting in bad faith towards its grocery store franchisees when expanding its corporately owned discount grocery stores. The Court stated that, although it was commercially reasonable for a franchisor to undertake changes to develop its system in tandem with contemporary market realities, it had to do so in ways that would not injure or destroy the franchise relationship.
If the franchisor intends to operate two competing systems, then again the issue of encroachment must be reviewed. In the Shelanu Inc. case discussed above, the franchisor opened a smaller, but nearly identical franchise system targeted at a slightly different group than the original franchise system. The Court found that the establishment of a direct competitor was fundamentally at odds with the obligation to deal in good faith and that, without the agreement of the franchisees of the original system, the franchisor could not properly and fairly institute the new concept. The law may not view the purchase of an existing system, where competition pre-existed, in the same light as creating a new one, as in the Shelanu case, but decisions made after the common ownership will be scrutinized by franchisees much more closely as franchisees of both systems will not want the other to receive any unfair advantage.
Although there can be no certainty as to the outcome of negotiations with franchisees of the acquired system, the acquiring franchisor is best advised to make itself fully aware of the potential hidden costs of the acquisition and budgeting an appropriate amount to cover such costs prior to completing the purchase.
The Hidden Costs Of Acquiring Another Franchise System - To learn more about this author, visit Peter Macrae Dillon's Website.
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Generally speaking, when a franchisor makes the decision to acquire another franchise system, it is looking for a similar system in the hope that some economies of scale can be realized. The franchisor may also be acquiring some unexpected legal headaches that should be fully flushed out prior to completing the acquisition.
The franchisor may want to add or subtract certain items from the acquired franchisor’s (“Newco’s”) system to either allow for additional distribution of the franchisor’s product or to make the systems more similar. Otherwise, the acquiring franchisor may have plans to convert Newco’s system to the franchisor’s system.
As the acquiring franchisor conducts due diligence on Newco, it should review Newco’s existing franchise agreements to determine whether or not language is included that allows the franchisor to add to, subtract from, or alter the existing system at its discretion. The franchisor should also plot the locations of Newco’s franchisees on a map to determine whether any of them are within the trading area of the franchisor’s franchisees.
Although the franchise agreement may allow for an altering of the product mix with Newco’s franchisees, the acquiring franchisor must take in into account its duty of fair dealing in exercising any discretionary powers under the franchise agreements, a duty that is codified in Ontario and Alberta under franchise legislation in the two provinces. If, for example, the franchisor decided to require Newco’s franchisees to stop selling a product that competes with the franchisor’s system and there is no independent reason for doing so other than the elimination of the competitive product for the benefit of the franchisor’s franchisees, the franchisor may be seen to be not acting in good faith. In Gateway Realty Ltd. v Arton Holdings Ltd. and LeHave Developments Ltd, a Nova Scotia court has held that bad faith is:
when one party, without reasonable justification, acts in relation to the contracts in a manner where the results would be to substantially nullify the bargained objective or benefit contracted for by the other, or to cause significant harm to the other, contrary to the original purpose and expectations of the parties.
In the above scenario, there may also be competition law issues if the result of a product removal is to unduly lessen competition.
If the product being replaced was unique to Newco’s franchise system and the removal of the product, would “substantially nullify the bargained objective” of the franchise agreement, then the franchisor should proceed with caution. The practical consequences of introducing new products or re-branding locations is that it may cost the franchisor a significant amount of money to coerce franchisees into making the required changes if the changes would result in a franchise fundamentally different than what the franchisee had originally bargained for.
The franchisor may decide that it will stop promoting the growth of one system over the other. In the Ontario case of Shelanu Inc. v. Print Three Franchising Corp. the court held that there was nothing in the franchise agreements which required the franchisor to maintain a certain level of franchisees. That being said, if the franchisor stops promoting the Newco brand, it may be open to liability for misrepresentations made in marketing materials or other representations made to franchisees with respect to building a certain number of new stores to help support marketing and brand name awareness.
If the franchisor’s goal is a complete re-branding of Newco’s system, the franchisor should have, in advance of the acquisition, mapped out areas of potential conflict that would result in franchisees of both systems competing too closely or encroaching on one another. The leading Canadian case on encroachment is a 1995 Quebec case, Provigo Distribution Inc. c. Supermarche A.R.G. Inc. In that case, the Court found Provigo, the franchisor, to be acting in bad faith towards its grocery store franchisees when expanding its corporately owned discount grocery stores. The Court stated that, although it was commercially reasonable for a franchisor to undertake changes to develop its system in tandem with contemporary market realities, it had to do so in ways that would not injure or destroy the franchise relationship.
If the franchisor intends to operate two competing systems, then again the issue of encroachment must be reviewed. In the Shelanu Inc. case discussed above, the franchisor opened a smaller, but nearly identical franchise system targeted at a slightly different group than the original franchise system. The Court found that the establishment of a direct competitor was fundamentally at odds with the obligation to deal in good faith and that, without the agreement of the franchisees of the original system, the franchisor could not properly and fairly institute the new concept. The law may not view the purchase of an existing system, where competition pre-existed, in the same light as creating a new one, as in the Shelanu case, but decisions made after the common ownership will be scrutinized by franchisees much more closely as franchisees of both systems will not want the other to receive any unfair advantage.
Although there can be no certainty as to the outcome of negotiations with franchisees of the acquired system, the acquiring franchisor is best advised to make itself fully aware of the potential hidden costs of the acquisition and budgeting an appropriate amount to cover such costs prior to completing the purchase.
The Hidden Costs Of Acquiring Another Franchise System - To learn more about this author, visit Peter Macrae Dillon's Website.
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John PowerJohn Power, founder of Biltmore Franchise Consulting, has extensive experience developing and marketing franchises and business opportunities. He has been in and around franchising for over twenty years. From 1980 through 1990 he conceptualized, organized, and developed the American Video Association. He grew AVA to 2,000 national members, before selling the company it 1990. It was later merged into another home video marketing company. From 2000 to 2005 he worked as a contract marketing and human resources consultant to several local and national companies. In 2005 Mr. Power began working as a franchise development consultant on a full-time basis. Since that time he has helped more than three dozen companies initiate and develop their franchising program. He notes that there are many companies interested in developing a franchise program, and who need his specialized assistance. Mr. Power is a “hands-on” franchise consultant. He said, “I am the ‘nuts and bolts’ person who tends to the details for my clients.” Mr. Power holds a B.S. degree with a major in Marketing. See: www.biltmorefranchise.com You may contact Mr. Power at: jpower@biltmorefranchise.co - Visit John Power's Website |
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Anne BarrAnne Barr has over 26 years experience in sales and marketing, six years as a franchisee. She has assisted over 367 business owners and purchasers to achieve their goals in career change, transition and exit strategy. She holds the designation of Certified Franchise Executive from the International Franchise Association, Certified Business Intermediary from the International Business Brokers Association and Board Certified Broker from the Texas Association of Business Brokers. Anne is active in professional organizations, networking groups and volunteers for non-profit entities. As owner/operator of four successful businesses, Anne has proven people skills and enjoys helping clients find the right "fit" in business ownership. Visit www.FranchiseOpportunitySpecialist.com for more information about me and my company. - Visit Anne Barr's Website |
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John BrennanJohn Brennan Ed.D. Dr. Brennan is President of Interpersonal Development, LLC, a training and development firm. Interpersonal Development has provided sales training and coaching to more than 3,000 sales reps from over 100 companies. A native of Australia, Dr. Brennan received his doctorate from the University of Rochester. His dissertation researched the effectiveness of Behavioral Modeling Technology in training people in interpersonal skills. While he has spent most of his career designing or delivering training, he was also a Vice-President of Sales of a training and development franchise with operations in 25 markets. Dr. Brennan has designed and delivered sales training in North America, Asia, Europe, Australia and the Middle East. He has been a guest speaker at numerous national and regional professional conferences. When Microsoft wanted Best Practices articles on sales for their web site, they called Dr. Brennan. The results are at http://office.microsoft.com/en-us/FX011387391033.aspx His firm’s clients have included Volvo, The Prudential, Merrill Lynch, Eastman Kodak, Gannett, Equifax Europe, the Economist Group and countless small businesses. - Visit John Brennan's Website |
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Jay Kubassek(Jay's Full Bio: EvanCarmichael.com/jaykubassek) In five years, Canadian-born entrepreneur Jay Kubassek went from selling mufflers at a Midas franchise to revolutionizing Internet marketing with the 2004 launch of CarbonCopyPRO, a online marketing education company, now worth over $20 million with customers in over 160 countries.
As an independent film producer, his upstart film fund Aliquot Films is currently producing a films with Spike Lee and Abel Fererra (starring Ethan Hawke and Dennis Hopper.)
Jay's entrepreneurial spirit is irrepressible. He’s the owner of five companies, a professional speaker and trainer, international real estate developer/investor, extreme sport enthusiast and emerging philanthropist. Jay resides in NYC with his wife Jamie, son Milo and dog Cooper. Visit Jay's official website: www.JayKubassek.com - Visit Jay Kubassek's Website |
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