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Takeovers and management buyouts can cause franchise disputes.

Updated: May 16, 2023

meeting between franchisor and franchisee

History tells us that when there is a change of ownership in a franchised business it is often bad for the franchisees.

Very few businesses remain in the same ownership for more than one generation. Most founders eventually sell out and businesses that are already in corporate ownership are often sold on. When that happens, new management takes over and the rules of engagement change dramatically. The objective is to justify the purchase and secure a satisfactory return on the investment. If the new owners are familiar with the industry, even possibly already owning similar businesses, they will have a clear insight into how to make the new acquisition more profitable. If they are new to the industry, they will nearly always introduce tighter controls. Either way, the manner in which the business has been run changes and every aspect is closely scrutinised. Assets are made to sweat.

There are numerous ways in which short-term measures can generate more profit in a business. These include intensive marketing to increase sales, cost cutting to reduce operating costs and squeezing or switching suppliers. All of these can greatly change things for the franchisees.

Not all franchisees will welcome more business. Some will already be enjoying their preferred work-life balance, some may not want to take on the extra responsibility of increasing staff numbers. Higher sales may require further investment that the franchisee doesn’t want to make at that point in their career. All these factors are perfectly justifiable for the franchisee but not for the new owners of the business. They will see a reluctance to welcome more sales as stifling growth and failing to comply with the initial commitment to operate the business as the franchisor requires. Conflict is inevitable.

Considering franchise profit and loss

Improving efficiency and reducing operating costs will probably include introducing tighter controls on the franchisees. This won’t be welcomed by independently minded individuals who just want to get on with the job as they always have done. Reducing costs may involve cutting the spend on benefits for the franchisees such as a company golf day or an annual day of awards and a gala dinner. Support visits by a business development manager may be replaced by a less personal Zoom meeting.

A change in suppliers may bring a reduction in service levels or delivery arrangements. Established work routines may have to be adjusted. Overall, the move from the light-touch management of a founder to a corporate drive for more profit by a new owner is a breeding ground for discontentment by the franchisees.

If cost-cutting involves reduced customer-service levels or a cheapening of products or services that are supplied by the franchisees, customer satisfaction may reduce. It is the customer facing franchisees who will be the first to feel this. And they are likely to resent it.

The worst offenders in this area are large corporates, private equity investors and venture capitalists. Not all multi-brand franchisors operate in this manner, but some do.

The recruitment of new franchisees following a takeover or buyout can also be problematic. An experienced franchisor will be more risk averse and cautious when making a decision to accept a prospective franchisee. A new owner will place a high priority on growth, increasing the capacity of the business and generating the maximum amount of revenue from recruitment. Managers will be instructed accordingly which may result in a lowering of standards, accepting inadequately funded prospects or condoning a higher failure rate.

franchise strategy meeting

A major consideration factor for a prospective franchisee are the financial projections that show the level of profit that can be expected. These should be based on the average of the existing franchisees. It is possible that the process of generating more profit for the franchisor has caused a reduction in the profitability of the franchisees. If the sale or buyout has only recently taken place a projection showing previous annual franchisee profitability will not show the current situation.

When a management buyout takes place, the managers become the owners and it is inevitable that they will try to demonstrate that, free from the control of their former boss, they can run the business more effectively. They will be far more concerned about the profitability of the business because they will have invested to pay for the purchase. If borrowings are involved, they may have had to give personal guarantees. These factors will change their perspective and instead of their emphasis being on maintaining a harmonious relationship with the franchisees they will become far more profit orientated. This may come at a cost to the franchisees.

It would be very unusual for a sale or buyout to be announced before it has taken place. The reasons for this are obvious but from a franchisee’s perspective it can easily be interpreted as a betrayal of the concept of the franchise being a partnership between the franchisees and the franchisor. Franchisees, quite rightly see themselves as major stakeholders in the business. Without them and all the hard work that they have done the business would not be valuable. Now, without any discussion, consultation or warning, the owner has sold out and very probably walked away. It is understandable that this can cause resentment and feelings of being under-valued.

For all these reasons it is hardly surprising that business sales or management buyouts in the franchising industry are often problematic and can lead to disputes. Those considering joining a franchise should make suitable enquiries and be aware of the numerous factors that can adversely affect their chances of success.

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