Reverse Take-Overs: When the Master Franchisee Becomes the
Franchisor
21 November 2007
First published in Franchising Business & Law Alert,
November 2007
Franchise attorneys are quite familiar with management buyouts
(“MBOs”) and have perhaps assisted or consulted in such
transactions. Now comes along a new phenomenon in international
franchising: master franchisee buyouts (“MFBOs”). An introduction
to MFBOs follows, using examples of two recent transactions.
In May 2007, the owners of the Master Franchise for ChipsAway in
the United Kingdom, ChipsAway International Limited (“ChipsAway
UK”), signed a deal with its U.S. franchisors, ChipsAway, Inc.
under which ChipsAway UK bought the global intellectual property
rights (“IPRs”) from ChipsAway, Inc., including the ChipsAway trade
marks and the “secret formula” for its paint and lacquer products
which make the ChipsAway repair system unique. ChipsAway, Inc.
retained the IPRs for use in the U.S. only. ChipsAway UK can
therefore now exploit the entire global market (excluding only the
U.S.) without the shackles of its master franchisor. This deal not
only substantially increases the value of the U.K. business, but it
also provides more stability for the U.K. franchisees and boosts
the value of all their businesses, while relieving the U.S.
business of the unwanted burden of running an international
franchise network.
Deals such as ChipsAway are becoming more common. Last year,
Field Fisher Waterhouse acted in a similar deal for another U.K.
master franchisee, MRI Worldwide Network Ltd., in its buyout of the
global business of franchisor MRI Worldwide Inc. Under that deal,
the parties also split the global ownership of the MRI IPRs into
U.S. and rest-of-the-globe companies.
MFBOs are a new phenomena in international franchising.
Previously, franchise buyouts such as those seen in the UK in the
Athena and Pierre Victoire chains were a method of releasing
franchisees from an insolvent domestic franchisor. MFBOs are an
entirely different animal. They are a way of taking a successful
business to the next level when the franchisor does not have either
the will or resources to do so but does not wish to divest itself
of its domestic business.
MFBOs require a sophisticated master franchisee; indeed, the
master franchisee’s resources and capabilities can exceed those of
its franchisor. Take the ChipsAway deal as an example. Under the
original master license between ChipsAway UK and ChipsAway Inc,
ChipsAway UK had the global rights to franchise the system and
IPRs, excluding only North America. The current management of
ChipsAway UK had, during its tenure, built the franchise to around
380 U.K. unit franchisees; this included a number of master
franchisees in countries as diverse as Russia, South Africa, and
Germany, to name but a very few. On the other hand, the U.S.
business was primarily limited to its home state of Pennsylvania.
The balance of power and resources was hardly typical of the common
franchisee/franchisor relationship.
In the international arena, it is not unusual for the franchisee
to be a more sophisticated and well-resourced business than its
franchisor. A number of master franchises in the Middle East, for
example, are owned by extremely wealthy families or businesses that
own whole “stables” of franchises for high-profile Western brands.
In these types of relationships, the balance of power is very
different from that found in the relationship between a franchisor
and its domestic unit franchisees. This difference in the balance
of power leads to more balanced commercial agreements between the
parties than the one-sided unit franchise agreement that often
receives criticism.
However, the equal power of both parties (or greater power of a
master franchisee) can lead to a divergence of views and ambitions
and, ultimately, to disputes.
A real alternative to litigation?
While both the ChipsAway and MRI deals were positive commercial
responses to the wish by all those involved to exploit the full
potential of the business on the international front, MFBOs could
also be a positive alternative to litigation between the franchisor
and its master franchisee. Many franchisors rush into international
expansion via franchising before they are ready and without proper
thought and advice, often when someone visiting the franchisor’s
country from abroad sees and likes the concept and approaches the
franchisor to take it back to his own country. As a result, it is
often only after the master franchisee has started trading that the
franchisor realizes that it does not have the resources and
expertise to run an international franchise business.
The sophisticated master franchisee might start to view its
less-ambitious franchisor as a hindrance, rather than a source of
help and support. The terms of the master license can restrict the
master franchisee’s expansion plans and frustrate the master
franchisee. At this stage, the master franchisee might want freedom
from the master license and unrestricted ownership of the IPRs.
This frustration could lead to the parties falling out, which in
turn can lead to litigation. An MFBO would most likely be a better
solution.
Providing for an MFBO in the Master License
Forethought on the part of franchisor, master franchisee and
counsel can bring MFBOs into consideration at the start of a
business relationship. Master franchisees should give serious
consideration to seeking from the franchisor a pre-emptive right to
purchase the franchisor’s business when initial negotiations are
conducted. This may come as a surprise to the franchisor and
receive an initially frosty reception, but if it is merely a
pre-emptive right of first refusal (rather than the right to
unilaterally require the sale of the franchisor’s business) the
franchisor is giving very little away, but the master franchisee is
obtaining a real benefit. Raising the issue at the outset of
the negotiations is likely to result in the best terms for the
Master Franchisee as, at that stage, it may appear an unlikely
scenario for the Franchisor. One option is to include a small
fee within the initial fee by way of consideration for the
pre-emptive right. The right would usually be limited for the
term of the MFA and, say, 6 months following expiration (although
note that the right may be lost if the master franchisee is in
breach).
Structuring an MFBO
There are a number of ways in which an MFBO can be structured.
It could be a full buyout of the franchisor’s business, a division
of the ownership of the IPRs on a global basis via a co-existence
agreement (for example one party having ownership of the IPRs in
the Americas with the other having EMEA), or a buyout and a license
back by the master franchisee of the IPRs to the franchisor (a
complete reverse of the relationship). However, in the latter case,
the franchisee-turned-franchisor will need to ensure that it
complies with local franchise disclosure laws. For a non-U.S.
franchisor that suddenly owns a franchise brand in the U.S., for
example, the disclosure laws can come as a surprise. There is no
one best structure for such a deal as it will depend in part upon
both the nature of the franchise business and the respective tax
positions of the parties.
Conclusion
An MFBO is not a simple nor quick transaction, and it needs
careful thought and specialist expertise. Yet it can be a very
useful tool for dispute resolution or to allow a frustrated master
franchisee to fully exploit the brand internationally. It is also a
further example of the great flexibility of franchising as a method
of international growth.
For further information, please contact Mark Abell or Victoria Hobbs.