Franchise deals tie owner's hands

Don’t assume the franchisor will automatically renew the agreement, and don’t expect to sell the business at the end of the term.

The Globe and Mail
July 6, 1998

Franchise deals tie owner's hands
John Southerst


Former Golden Griddle franchisee Murray Katzman was asked for the keys to his restaurant when the chain decided not to renew his contract after its 20-year term expired. 'I wanted to be entrepreneurial and they wanted me to be compliant.'

Franchise owners are sometimes shocked to discover that they don’t really own a business. They actually own the right to use a trademark over a limited period of time. At the end, the franchisor may choose not to renew, leaving the franchisee with nothing to sell except some used equipment and furniture.

That’s a long tee shot from the independent business owner who sells an entire company whenever he pleases.

Murry Katzman always saw himself as independent, and it may have cost him his business. As one of the original Golden Griddle restaurant franchisees, he spent 20 years operating his outlet in a northern Toronto suburb. In April, when the 20-year term expired, Golden Griddle Corp. said goodbye to the 65-year-old grandfather and asked for the keys.

Mr. Katzman says his relationship with his franchisor over the years was “confrontational.” They clashed over what he saw as a lack of marketing support, and the use of two-for-one coupons that, in Mr. Katzman’s view, bump up revenue and royalties at the expense of short-term profit. He also insisted on devising unauthorized menus for the clientele in his mostly Jewish neighborhood.

“I didn’t view myself as an extension of Golden Griddle,” he says. “I saw myself as an independent businessman with a Golden Griddle franchise. I wanted to be entrepreneurial and they wanted me to be compliant.”

About six years into his agreement, he also started a franchisee association, which he says the franchisor viewed as a threat. On the other hand, he established a profile in the franchising community by appearing as a panelist and lecturer at bank seminars for branch managers and at franchising conventions.

Faced with the non-renewal of his franchise, Mr. Katzman went quietly. He investigated the legal concept of “residual rights” to compensation, which some U.S. state courts have said franchisees earn through their “sweat equity” over the years of operating their franchise. But there is no equivalent case law in Canada.

“How much would it cost me to be the guinea pig on residual rights in Canada?” he asks.

Answer: about $25,000 in legal fees – with no guarantee of winning. Mr. Katzman is now a broker for Tour + Med Travel Health Insurance, selling to Canadian snowbirds who winter in Florida.

His business wasn’t worth much when Toronto-based Golden Griddle took control. Revenue had fallen to $400,000 last year from $1.5-million in prerecession 1989. The store lost about $200,000 in the last five years of Mr. Katzman’s tenure.

So he thinks more about principles than about money. “They had every legal right to take over my business,” he admits. “Whether they were morally right in doing that – no, absolutely not. They took something away from me.”

In any case, the franchise agreement clearly said that all good will – the value of a business beyond the worth of its hard assets – resides in the corporate logo, and Mr. Katzman’s right to use it expired with his agreement.

“The decision we made was best for Murray and best for ourselves,” says Bill Hood, Golden Griddle’s executive vice-president. He adds there were many reasons for not renewing but notes that at Mr. Katzman’s age, few franchisees request another 20-year term.

Nonetheless, he says Mr. Katzman knew of the chain’s intentions for three years. “I always say to new franchisees going in, ‘You’ve got 20 years. You’ve got to calculate how long it will take to get your cash back, pay off your loan and provide a return.’”

In other word, prospective franchisees should take their all-in cost of leasehold improvements - $500,000 to $1-million isn’t unusual for a restaurant chain – add the franchise fee and divide by the term of the agreement. The result is the annual amortization of fixed costs, which has to be recovered over the agreement’s time period. And remember to add in variable costs such as labour, supply and maintenance.

Don’t assume the franchisor will automatically renew the agreement, and don’t expect to sell the business at the end of the term. Franchisees who want to sell their stores should do it in the middle of the term, not at the end, because there’s always a possibility of non-renewal.

“You can’t sell something that’s not there,” says franchise lawyer Paul Jones of Miller Thomson in Toronto, “so you have to sell with time left in the agreement.”

The buyer must then calculate how much good will he is buying, and whether he can recover it over the remainder of the agreement. It’s a common error to assume the franchisor will renew, justifying a higher purchase price and longer amortization period for advance costs such as good will.

Mr. Jones says good franchisors will use their contractual right to reject franchise sales where a high price sets unrealistic expectations for buyer over the course of the agreement.

“If the franchisee is making money for the franchisor, it’s certainly uncommon not to renew a long-term franchise relationship at the end of its term,” Mr. Jones says. That’s the case “even with a confrontational relationship with the franchisor.”

But as Mr. Katzman discovered in the final years of his term, both retail success and franchise relationships are always uncertain.

Terms and renewals· Franchise agreements may run from five years to as long as 20 years, although the latter is less common.· Agreements are renewed at the discretion of the franchisor.· With a renewal, the first line of defence is a good relationship with the franchisor. · Some agreements have an initial renewal term, after which the regular term kicks in. In calculating amortization of fixed costs, use the initial one because there is no guarantee of renewal.· If you are considering selling your franchise, plan for it near the middle of the term rather than at the end.

John Southerst is a Toronto-area writer on franchising issues who can be reached at ac.ratsi|htuosj#ac.ratsi|htuosj

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