Franchises in workouts

A common myth is that if business is part of a franchise that they do not qualify for the workout because the Franchisor will not cooperate with any workout process.  The holy grail of documents, the franchise agreement, simply would not allow it.  Transfer fees, past due royalties, future projected royalties, and a variety of other barriers will stop any potential sale or debt reduction.

This couldn’t be further from the truth.  Currently, Second Wind is dealing with over a dozen franchises very successfully.  What people seemed to forget is how the franchise relationship is structured.  Franchisors collect a percentage of revenue for each franchised location.  As the franchisees lose their revenue, so does the franchisor.  These companies, while larger and stronger than your average small business, have also played victim to the recent economic woes.  They cooperate within workout strategies because we make the best out of a difficult situation for them, in a very similar manner that we do for secured banks.  Listed below is are a few examples as to how and why franchises have handled workout scenarios in the past.

Transfer Fees: Many franchise agreements will stipulate a large franchise fee in order to allow any private sale to occur to a new owner.  However, when the alternative is allowing a location to permanently close due to overwhelming secured debt, the franchise will either reduce or completely eliminate any transfer fee… Think about it, their goal is to keep that location open and collect future royalties.  If the only buyer available is not willing to pay these pricy transfer fees, the franchisor is willing to negotiate on them in order to keep their long term income stream viable… We all know if the bank forecloses on the assets, there will be no transfer fee and no future royalties

Past Due Royalties: We recently settled $70,000 in past due royalties for less than $5K.  Why would the franchisor cooperate?  Simple, my client sold off his franchise, has a secured note which was attached to his house and secured by a priority unconditional guaranty, his real estate was under water, and he had little cash reserves.  $5K was a good return for the franchise, given that if my client had filed bankruptcy they would have received no proceeds whatsoever.  They did not even have to go through the time and effort of obtaining judgement.  It gave a favorable solution to both sides of the equation.

These are just a couple of examples as to how franchise do fit into the workout equation.  The key is to meet their goals as well as your own.  If you completely ignore a franchise, you could create a costly future mistake for yourself.  On the flip side, if you involve them too much or fall too far behind on your royalty payments without communication and you can run the risk of having the franchise move in to take over operations of your business.  The sweet spot finds itself somewhere in the middle.  Respect the franchise variable in the equation properly and you can very successfully strip debt and preserve the business opportunity