In several sectors of activities, despite various government assistance programs and, in many cases, various forms of assistance and support from their franchisors and, in some cases, their lending institutions, suppliers and lenders, franchisees are still emerging financially weakened from the recent period of forced containment and lockdown.
One way to improve the financial health of a franchisee at the end of this long crisis is to add a partner who will make a financial contribution to the franchised business.
The addition of a partner to an existing franchisee is also one of the recognized means of initiating a process of succession to the management and to the ownership of a franchised business.
Is the adding of a partner to improve the financial situation of a franchised business a good solution?
The answer to this question is often in the affirmative, but under certain conditions for both the franchisor and the franchisee.
The franchisor has an obligation to take reasonable steps, based on an obligation of means, to enable its franchisees' businesses to be financially profitable (it being understood that the franchisor is not a guarantor of the profitability of each franchised business).
The franchisor must therefore avoid the addition of a new partner to an existing franchisee becoming, in the medium or long term, the source of a more serious problem than the one initially attempted to solve.
Such a new partner may be another franchisee, a prospective franchisee, a contact of the franchisee, an investor, or an employee of the franchisor or of the franchisee.
Regardless of where the new partner comes from, it is essential that she/he (i) meets the standards and criteria required by the franchisor of any new franchisee, (ii) makes a positive contribution to the franchisee's business, and (iii) is willing and able to work closely with the existing franchisee over the long term in the direction, management and operation of the franchised business. The compatibility ("chemistry") between this new partner and the existing franchisee is very often the key to the success of such an addition.
The selection of such a new partner is therefore a delicate operation in which both the franchisor and the existing franchisee must actively participate.
One way to properly test the level of common understanding and compatibility between the existing franchisee and the new proposed partner from the outset is to ask them to jointly prepare a new business plan for the franchised business.
Beyond the resources, personality, attitude and skills of the new partner, the new partner's objectives, expectations, management style, contribution, expected duration of the contribution and the sharing of responsibilities with the existing franchisee must be clearly known, understood and... accepted by both the franchisor and the existing franchisee. Similarly, the vision, objectives, needs and expectations of the existing franchisee and the franchised business must also be clearly known and accepted by the new partner.
Through adequate corporate planning, it is possible to modulate the participation of the new partner according to his expectations and objectives (among other things, by properly drafting the rights, privileges and restrictions attached to the shares of the franchised business that will be issued to her/him and the clauses of the partners' or shareholders' agreement).
It will also be necessary to carefully circumscribe the initial contribution of the new partner. If the goal is to improve the financial situation of the franchisee's business, it must be ensured that this contribution is made to the franchised business (for example, by the acquisition of new shares issued by the business) rather than to the existing franchisee (for example, by a partial purchase of the shares already held by the franchisee in the franchised business).
The tax aspects of this transaction will also need to be considered. For example, the fact that a new shareholder subscribes for shares of the same class as those issued to the existing franchisee may cause a dilution of the paid-up capital of those shares, which could result in an unfortunate tax impact at the time of their redemption.
In many cases, this new partner will have to be approved by the financial institution of the franchisee and, in some cases, by the lessor of the franchised business location.
The new partner will also be required to bind itself in writing to the franchise agreement and to the other agreements between the franchisee and the franchisor.
Another fundamental component to the success of adding a partner to an existing franchisee will be their partnership or shareholders' agreement.
It is essential that such an agreement, properly drafted, negotiated and understood, be signed prior to the commencement of any such partnership.
Without going into all aspects of such an agreement, it is essential that it provide each of the existing franchisee and the new partner with a clear and reasonable outcome in the event of disagreement between them (which occurs much more often than the cases of death, disability or withdrawal of business found in most partners/shareholder agreements).
In franchising, this also raises the following question: should the franchisor impose the text of the partners' or shareholders' agreement or, at the very least, require that this agreement be approved by it before it is signed?
In our experience, this is generally not a good idea.
In fact, this agreement is the key agreement governing the relationship between the partners or shareholders of the franchised business. It must therefore be theirs first and it must be satisfactory to them.
The fact that the franchisor imposes the content of the agreement or requires its approval is likely to put the franchisor in a very uncomfortable position in the event of a dispute between the partners or shareholders, especially if the agreement does not provide a clear and adequate response in the circumstances (which, in our experience, unfortunately happens all too often).
However, we strongly recommend that the franchisor require such an agreement to be signed prior to the beginning of the partnership and, also, that such agreement stipulates (i) that, in the event of a discrepancy or contradiction, the franchise agreement will, in all cases, take precedence over the shareholders' or partners' agreement, and (ii) that no default by any of the partners or shareholders under the partnership or shareholders' agreement shall be enforceable against the franchisor to justify the franchisee's failure to comply with any of its obligations under the franchise agreement.
Another possible scenario for adding a new partner to an existing franchisee is that the franchisor itself acquires an interest as a shareholder of the franchised business.
This possibility, however, raises a number of specific issues which we discussed in our Bulletin entitled Is it Ever Wise for a Franchisor to Become a Shareholder of its Franchisees?
Fasken has all the expertise and resources to help you draft agreements that are complete, adequate and protect your rights, while avoiding potential pitfalls.