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Master franchising in a new market

As the master franchisee, you are better-attuned to local consumers’ needs and habits than the foreign franchisor could be.

It is also important to determine which of the franchisor’s own employees will be made available to help and support you, e.g. in recruiting and training prospective franchisees and selecting franchise sites. A well-established, dedicated team of staff will demonstrate the franchisor’s commitment to international franchising, along with its budget and expense plans for international development.

You might also inquire about advertising funds and other promotional programs. Launching the franchise system in your territory will require a significant investment in marketing, after all, as you work to build a local reputation for the brand and, eventually, establish its dominance in the market. So, you should seek help from the franchisor with advertising, particularly in the first few months of your launch. Master franchising is a win-win situation when both parties put in the effort required to develop a new territory.

It is especially important to understand the process of modifying a foreign franchise system’s documents and agreements to adequately meet the realities of the local market. Disclosure documents may need to be newly drafted, manuals translated and/or agreements adapted, all pending the franchisor’s review and approval of any changes.

Even a great business opportunity can become an unsuccessful venture if the franchisor and the master franchisee do not see eye to eye. It is of the utmost importance for you to share the same goals and business philosophies before moving forward.

Negotiating terms
Before negotiating an MFA, it is important to understand even the best agreement will not hold a franchise system together indefinitely—rather, it will need to be adapted constantly as the business grows. That said, negotiating a ‘bulletproof’ MFA will go a long way toward preventing litigation and speeding up the expansion process.

The basic goal of negotiations from the franchisor’s viewpoint will be to maintain control over the master franchisee, so as not to jeopardize the established reputation of the brand, but this control should not limit the master franchisee to the point where the relationship becomes inequitable. For one thing, you should not be cornered into ‘obeying’ rather than ‘collaborating,’ but for another, excessive control can expose the franchisor to greater third-party liability in franchisee claims. So, it is in both parties’ interest to negotiate a well-balanced MFA and a proper distribution of power.

The following are a few of the clauses that will need to be carefully thought through when negotiating and drafting the MFA.

You should obtain and carefully review the franchisor’s disclosure document.

Initial fees and royalties
By and large, the initial fees and royalties are the most-disputed provisions in an MFA.

As the master franchisee, you will need to pay the initial fee for the rights granted by the franchisor, which will normally be calculated according to the size of your territory and projected sales and profits. There is no fixed or standard method, however. Some MFAs will use the ‘cost recovery’ method, whereby initial fees are calculated based on the recovery of the costs associated with the development of franchises over time—typically, the critical first two years—along with the cost of putting a licensee in place within the given country. Another method is establishing a ‘rate of return’ by projecting revenue and expenses at the master and unit level, as well as the number of units to be opened over a set period. Some fees are lump sums, while others are initially very small and then followed by ‘pay-per-unit’ fees.

Royalties, meanwhile, will constitute your own main source of revenue as the international master franchisee. You should receive a steady stream of income from your franchisees, which in turn will help sustain the process of brand development and growth in your market.

Thorough due diligence will go a long way in building a solid case for your negotiations with regard to the amount you pay for the initial fee and the percentage you receive of the royalties generated. This is why the pre-contractual phase is so important, even though it is often neglected.

Again, the franchisor and the master franchisee have mutual interests. If you cannot support yourself financially, that will have a negative effect on the reputation of the franchisor’s brand. If you are left without resources from the franchisor, you will need to fund your own development, training and marketing efforts, among other business activities. In this scenario, you will be faced with the decision to (a) not many any profit or (b) cut down on development, so it is arguably to the franchisor’s own advantage to (a) cut back the initial fee and/or its own share of the royalties or (b) get more actively involved in the expansion effort.

This dichotomy often fuels fierce negotiations, which is why both parties are encouraged to agree from the onset of their relationship to a clear letter of intent, outlining general figures for both the initial fee and the ongoing royalties.

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