Franchise Defaults Are Skyrocketing

The numbers are staggering. It appears franchises are being extremely hard hit by this downturn. What appears worse is the way the franchisor is reacting. In many cases we see the franchisor not only refusing to work with the franchise, but actually becoming the biggest problem as the royalty formula breaks down when revenues fall.

Virtually all franchises receive a percentage of gross revenue as their royalty. Unfortunately, when revenues decline and profit declines, the percentage of gross revenue becomes a loss to the franchisor and forces the franchise into a downspin. As long as the royalty to the franchise is based on gross revenue, when sales slip, the franchise is doomed – not by the bank note but by the franchise royalty. Combined these things create a perfect storm, impossible to navigate when sales are dropping and profit slipping away. If the franchise is treading water, losing revenues and facing upside down operations, the percentage of gross revenue is pure loss paid out of cash flow, not out of profits. It does not work.

We have successfully worked out many, many franchises of all sorts, descriptions and types. Most often the workout has been focused on the secured bank debt and vendor debt, landlord debt, etc. Sometimes we get some cooperation from the franchisor but mostly in the form of modification, not forgiveness. Often, the franchisor simply abandons the franchisee and shuts them down, in other words, “Sets an example, holds standards.” Frequently the issue is whether or not it remains a viable relationship at all, and sometimes the franchisor is forced to “do it” without the franchise.

I understand the franchisor’s issues and problems, however, until they understand that they are as much a part of the problem and must become part of the solution, they will force more and more of their valuable units out of business and their cash flow with it. That does not work at all. However, they seem to be unwilling to grasp that reality, just as the banks are unwilling to deal with the inability of their borrowers to pay their notes.

Fortunately, we have stategies that support positive conclusions. There are options and alternatives. A workout is the answer. It takes many varied forms and shapes but it is the answer, the only viable option.