Franchise

Franchise as a business model is emerging over the last years. Besides the well-known international catering formulas and the Dutch retail formulas, several more formulas have developed over the past years in the business services sector. The main reason for this strong growth is that starting entrepreneurs like to cooperate with a franchise formula and those formulas have expanded greatly. Becoming a franchisee is popular.

Dutch franchise code

Statistics show that more than half of the starting entrepreneurs has to quit or goes bankrupt within a period of 3 years. This percentage is much lower with franchisees, although this does not mean that franchising is the right path for every starting entrepreneur and it also does not mean that franchising is a guaranteed success. Similarly not all formulas are suitable for franchising.
Recently the Dutch franchise code was introduced. Through a form of self-regulation in the franchise sector malpractices must be prevented. Franchising needs to be a balanced business model with a fair balance of rights and duties between the franchisor and franchisee.

How can the franchise be distinguished from regular entrepreneurship?

A franchise agreement is a commercial agreement in which an entrepreneur (the franchisee) operates an enterprise for own account and risk. He uses the formula or tradename which is owned by the franchise chain (the franchisor). The big advantage of franchising for an entrepreneur concerns the well-known name of the formula, for which he has to pay a periodic fee to the franchisor. An important characteristic of a franchise is the strict rules, issued by the franchisor. These regulations are often accorded in the franchise agreement and/or the guidebook. In many cases a rental agreement is concluded as well, apart from the franchise agreement. In such a case the franchisee rents a property from the franchisor, for which he has to pay rent. The design and appearance of the property and the products which are sold must comply with strict prescriptions from the franchisor. Only in limited degree the franchisee is entitled to the sales of other products.

Pitfalls

Our attorneys notice several returning issues and problems in the franchise practice. Pitfalls are often overlooked in the contract phase or not recognised in time afterwards. As soon as a conflict between a franchisor and franchisee forms it will evolve into a dispute with legal procedures as a consequence.

Some practical tips for franchisors:

• Inform your franchisee prior, correct and complete. Especially when you are active in retail and rent out a property, be extra alert. Many disputes come from false expectations which were formed with the conclusion of the franchise agreement. Revenue forecasts or business location investigations were not accurate or negligently drafted. There exist legal procedures in which the franchisee can claim successfully an error. It is better to not give any revenue forecasts and to agree that a franchisee himself makes the business location investigation before the exploitation starts.

• Meet your duty of care. Coach the franchisee and give sufficient support and advice (both requested and unrequested). Make sure you have professional marketing and an extensive guidebook. Make sure you have regular and structural meetings with your franchisees or install a franchise council. A timely detection of a store which is not profitable is essential. Be proactive when the first signs occur, like complaints from customers and/or non-payment of rents and other fees. Be reluctant with supplying on the basis of purchasing on account or payments via current account structures. Before you know the debt has risen so high that you are considered more a bank than a franchisor.
• Be strict and critical in the selection of franchisees, because not all entrepreneurs are suitable. Many starting entrepreneurs do not realise what it means to exploit a store on own account and risk. The franchisee has to arrange his own staff, the purchasing, the correct licences for the store, etc. Experience is required and a certain start-up capital or necessary financial buffers are strongly advisable.
• Last but not least: the formula needs to make a decent growth, but not at any cost. It is better to invest in continuing growth (quality), than in wild expansionism (quantity). Growth can also lead to cannibalism, where too close locations can steal each other’s customers. The formula does not profit from this in the end.

Some practical tips for franchisees:

• Finance your franchise location as much as possible from equity capital. Contributed capital (loans) have to be recouped. If the exploitation disappoints the financial burdens will keep down the profits.
• Let potential revenue forecasts or pretended revenues be checked by your own accountant and ask the financial records of previous years when you take over a location. Experience shows that many retail formulas deal with declining or stabilised revenues. When a revenue forecast has been too rosy with strong growth numbers which ultimately disappoint, this can lead to negative consequences. Also the location is important, because a ‘deflating’ side street in a shopping area or centre is less prospective than a location with sufficient pass-through. Inform in advance with other tenants on the pass-through and the rental prices.
• Let potential shop inventory be valued by a specialist in store valuations. The bulk of the formulas applies reasonable takeover prices, but unfortunately experiences also show that formulas exist who sell inventory for an excessive takeover bid.
• Always check the franchise- and rental agreement by your attorney. Franchisees often do not see the advantage of such a check and see this as unnecessary costs. When a dispute arise it is often too late and you learn the lesson through bitter experience. The Dutch rental law is complex and concluded rental contracts often are for a longer period of time (5 to 10 years). Furthermore a franchise agreement can consist of arrangements which would run counter to competition law or unclear agreements on remunerations exist.

Do you want to know more about franchise and rental contracts? Contact us without any commitments attached. Our attorneys possess yearlong experience with contract drafting and with termination of franchise relations in order to advise you. We advise both franchisors as franchisees.