Franchisees Must Keep an Open Mind About New Brand Owners

It is only natural for franchisees whose brands are acquired by a private equity firm to wonder what changes will take place, and how having a new owner will impact their bottom lines.

The advice franchise attorneys give franchisees when their company is sold to an outside investment firm is for them to research their new owners to understand how they’ve handled previous acquisitions. They also recommend being proactive by reaching out to their new bosses to open the lines of communication and collaboration.

“My experiences in these mergers and acquisitions are that there are two kinds of private equity firms that buy franchises,” said Ron Gardner, a partner at Dady & Gardner. “There are those that are in it for the long haul and will do the right thing for their franchisees, and there are those that do a turn-and-burn, meaning that they will resell the company in three to five years.”

Gardner, who’s based in Minneapolis and represents more than 50 franchisee associations, added, “It’s the ones that are in it for the short term and cut at edges of the brand by raising fees and eliminating corporate positions that franchisees have to be prepared for.”

With merger and acquisition activity poised to accelerate this year, Gardner said regardless of outcome, it’s imperative that franchisees do their due diligence to be better prepared for all scenarios. He also strongly recommended that franchisees reread their existing franchise agreements, determine the critical products and services they rely on and go over their legal rights with an attorney.

Gardner made it clear that although PE firms cannot increase royalty fees until the expiration or termination of existing agreements, they can adjust marketing and technology fees in most cases because of vague language in standard deals. He pointed out that franchisees that have been with the brand the longest and whose locations are performing at the top of their system almost always have the most leverage when it comes to renegotiating those costs and vendor agreements.

Expect some significant changes

“Franchisees need to remind PE firms that significant brand growth comes from the existing franchise base and it is in their best interest to incentivize them and play nice,” Gardner said.

Eleanor Vaida Gerhards, the national co-chair of the franchising and distribution group at Fox Rothschild, urged franchisees, especially those in their system the longest, to review the information provided by their advisory council or new owners to stay involved in the transition process. She also recommended they be ready to provide input to their new owners and not be afraid to share feedback with them about the brand, whether it’s good or bad.

“In my recent experience, franchisors are a lot more communicative with franchisees to earn their trust,” Gerhards said. “They want existing franchisees to remain happy in the system, renew their agreements and continue to grow.”

To pull this off, Gerhards said PE often brings greater resources, more personnel, technology, administrative support and a deeper bench to a system.

Still, Gerhards said franchisees in a brand that’s acquired by private equity can expect changes to their system and those changes are put in place for a reason. She recommended they do a comprehensive audit of their operations to ensure that they are complying with all current system standards and are not in breach of any terms of their franchise agreements.

“It’s really important that you are in good standing with approved vendors and suppliers,” said Gerhards, who advised franchisees to carefully evaluate requests for franchise amendments or new franchise agreements prior to their expiration and renewal dates.

“If the acquisition is structured as a sale of stock, then the selling franchisor remains the counterparty to the franchise agreement. If it’s structured as an asset sale, then the franchisor will assign the franchise agreement to the buyer,” said Gerhards. 

“Many buyers wait and then require execution of their preferred current form of franchise agreement when the franchise term is up for renewal,” she said. “However, PE may try to encourage franchisees to sign amendments to the current franchise agreement or replace the existing franchise agreement with their desired form before a franchise comes up for renewal.”

Gerhards cautioned that the buyer of a franchise system will have their preferred form of franchise agreements and that it will likely look very different than the one signed with the previous owners. 

“Make sure to compare the changes and discuss with a knowledgeable franchise attorney,” Gerhards said.

Amy Cheng of Chicago-based Cheng Cohen also urged franchisees to review their agreements before resigning them, taking into account their duration and investment, as well as the franchise they operate in.

Like Gardner, she stressed franchisees should be fully transparent in sharing with their new owners what worked and didn’t work for them in operating their locations under the past ownership. Additionally, they should be prepared to argue why receiving more corporate support and/or new vendor contracts will help improve their bottom lines.

“Their positive and negative feedback given to private equity helps both the franchisor franchisee understand the strengths and weaknesses of the system,” said Cheng. She pointed out that it’s always going to be in the best interest of franchise owners to maximize profitability of their franchisees because it’s their success which determines the success of the brand.