Things to Consider Before You Split With a Franchisee
Divorcing a franchisee is the act of removing a franchisee from, or asking the franchisee to leave, the franchise system. It can be messy and difficult, just like divorcing a spouse. But sometimes it's the only solution.
There are three ways in which you can accomplish the split:
- The most desirable option would be to transfer the franchise to another qualified franchise prospect. This can be done while the original franchisee is still occupying the location in order to facilitate a smoother transition. If this is not possible, you can send in a management team to manage the location until a new franchisee is found to take over the location.
- A less desirable option is to close the location down through court action against the franchisee.
- The third option would be to allow the franchisee to continue operating independently from the location using a different brand not associated with the franchise system. This is not recommended, for reasons which are outlined below.
Transfer of the Franchise
This is the best method of removing a non-system franchisee from the franchise system, because you are in control of the process.
- The franchisee pays for the ads, advertising that the franchise business is for sale.
- The calls from the ads and any other leads are taken by the franchisor or its agent.
- The franchisor processes the candidates as it would any candidate for an unopened location, using the same recruitment criteria.
A key problem that franchisors face is the pricing of the franchise business. If left to the franchisees, they tend to overvalue their business. For this reason, it is best to enlist the services of an outside third party that specializes in evaluating companies, to determine the fair market value of the business.
Ideally recruitment of a new franchisee can be done while the existing franchisee is still managing the business, however there will be times when the relationship has deteriorated to the point where the franchisee's presence will be a deterrent to both the transfer of the franchise and to the system as a whole. When this occurs, the franchisor is faced with two possible actions:
- Place a manager in the location to manage the business until a suitable transfer candidate is found. In this case, the costs of the manager would be paid for from the gross sales of the location. Any losses would come out of the price paid by the transferee for the business. Any profits would go to the franchisee.
- Close the location. This option would undoubtedly result in legal action being taken by the franchisee. Before considering this option, BE SURE that your documentation is strong enough to support taking such drastic action.
Closing the Location
There may be occasions when the continued operation of the location by the franchisee is so detrimental to the franchise system that yuou are forced to take immediate injunctive action to force the closure of the location. Be prepared for the following:
- Thorough disclosure of all documentation justifying the need to close the location. It will be helpful if you can prove that the franchisee is negatively affecting the reputation of the brand and that your other franchisees are suffering financially as a result.
- A legal challenge by the franchisee to prevent the closure. This will add to your legal bills. However, if you have properly documented the problems you will probably get the injunction. It has to be black and white, however, with no grey areas, otherwise you stand little chance of success.
As part of the injunction you will also file a suit for damages which may include:
- Loss of royalty revenue due to the location being closed.
- Payment of royalty revenue in arrears, as by this time the franchisee will undoubtedly have stopped paying royalties.
- Your costs for the legal action.
It is NOT TRUE that the courts take the side of the franchisee because of the David & Goliath syndrome. The courts always look at fair dealings. So if the franchisor has been fair in all of its dealings with the franchisee, and the franchisee has not been equally fair in its dealings with the franchisor, then the courts will find in favour of the franchisor.
Allowing the Franchisee to Operate as an Independent
This is never recommended. If the franchisor allows this to happen, it will mean the destruction of your franchise system. At no time should this be considered as a viable option.