How Franchisors Can Help Franchisees During the Pandemic

September 1, 2020by Brian Walsh

The widespread and continued presence of the Covid-19 virus is unprecedented in modern history. According to the World Bank, the virus has brought worldwide “economic activity to a near-standstill.” Gross Domestic Product (GDP) in the United States experienced its largest single-quarter decline of history in the second quarter of 2020 (-9.5%), with comparable drops in consumer spending and confidence. When recovery might begin is unknown as are the long-term effects of the pandemic.

Bar graph of franchise establishments in the United States from 2007 to 2020, by business line (in billion U.S. dollars)

Economic Impact Of
The U.S. Franchise Industry

The franchise industry has always been a significant contributor to U.S. economic growth and employment. Before Covid-19, U.S. franchise establishments numbered 733,000 units and employed more than 8 million workers. Thus far, in 2020, franchise job losses exceed more than 1.3 million. The number of franchisees forced to close their doors this year is unknown, but the carnage is significant.

Special Relationship

Franchisors and franchisees enjoy a symbiotic relationship unique among business organizations. In return for an established brand, know-how, and access to specialized suppliers and marketing programs, franchisees typically pay an upfront license fee and an on-going royalty. The obligations from one party to the other generally are extensively detailed in a franchise agreement between the two. The arrangement effectively melds the interest of the two parties together: the franchisor benefits when its franchisees do well.

While the franchisee is not guaranteed to be successful, they gain from the experience and relationships of the franchisor, potentially avoiding the start-up problems met by new businesses. A successful relationship can last for decades.

Covid-19 Consequences

Few franchisors or franchisees expected an economic event with the impact of Covid-19. Historically, when an individual franchisee faced financial problems due to its operational difficulties, the franchisor’s only legal obligation might be to supply additional consulting services. Since the bulk of the franchising network remained intact, the loss of a single or a few units – not being financially significant to the franchisor – did not justify the expense or effort of extraordinary measures.

Today, a franchisor who does not work with its franchisees to survive the current crisis jeopardizes its existence. Since both parties’ futures are intertwined, staying on the sidelines – letting their franchisees struggle alone – is not a practical option. An astute franchisor will proactively address each of the following categories where problems might arise:

Franchisor/Franchisee Relationship

Misunderstandings between franchisors and franchisees are not uncommon and frequently end in costly legal expenses for both parties. When a franchisee considers the franchisor as the problem rather than the solution, issues inevitably arise. In some cases, franchisors must contend with class-action lawsuits.

During times of financial stress, tensions are high on both sides. It is also an opportunity to mend fences and recover the lost trust between the parties. Franchisors that recognize that the relationship with franchisees is mutually dependent and act with trust and full communications while focusing on service, customers, and profitability.

Programs that strengthen relationships in chaotic times like 2020 are steps a franchisor can take to rebuild or maintain a stable relationship with its franchisees.

Legal

It is critical to work with a franchise attorney to have a thorough understanding of the  legal obligations laid out in the franchise agreement , especially the force majeure provisions. Often written as boilerplate, these clauses are present to release a contractual party from its obligations if an event outside its control occurs. Typically, the events include war, civil unrest (terrorism), government restrictions, or natural disasters. Whether Covid-19 is considered force majeure will depend on the specific language in the franchise agreement. Competent legal advice is essential.

During financial difficulties, franchisees are likely to seek relief on royalty payments and mandatory expenses for advertising or other joint expenses. Some may pursue the termination of the franchise agreement. Knowing your legal rights and obligations might avoid the added expenses of contesting their actions in court.

Financial

The loss of customers and their associated revenues create tremendous cash flow problems for franchisees, especially those who deal with the public. In the short term, programs to boost revenues are less effective than cutting expenses to cover cash flow deficits. Direct measures that franchisors can take to help their franchisees survive the Covit-19 crisis include

  • Eliminate or defer obligations to open new units or remodel existing units
  • Communicate details of Federal and State programs intended to benefit small businesses such as the Paycheck Protection Program or Economic Injury Disaster Loans. Encourage those franchisees initially funded by SBA loans to renegotiate to defer or reduce payments due to Covid.
  • Defer royalties and other contributions to joint franchisee programs
  • Develop replacement products or services designed for remote use (take-out food, added online capabilities, delivery)
  • Reduce operating hours to minimize payroll and other direct costs
  • Help with landlord negotiations to lower or defer rents
  • Negotiate and share supplier rebates and extended payment terms
  • Reinforce franchisee presentations to lenders for new debt or extension of debt repayments (preparation and help with funding requests)

Supply Chains

The difficulties created by Covid-19 are not limited to the direct operations of businesses, often extending to the supply chain. While modern technology has expanded markets globally, the advantage required the development of a complex network of suppliers and sub-suppliers intended to reduce excess supplies by just-in-time inventory strategies. The spread of Covid-19 disrupted production and delivery through complex, interrelated transportation and communication networks. For example, franchisees dependent on products from China are currently coping with supply shortages due to lower production or products diverted to domestic use.

As supplies of products and services critical to franchisee operations declined, their prices rose, further weakening already stressed franchisees. For example, the Big 4 of credit card issuers – Visa, Mastercard, American Express, and Discover – announced new fee schedules increasing the costs to process a credit card charge as much as 25%. For many franchisees, the cost of processing credit cards often exceeds the cost of labor.

Franchisors can renegotiate agreements with suppliers to get better services or rates for their franchisees, including telephone service, merchant exchange fees, internet, and supplies of all sorts. Negotiating power correlates to volume, and a franchisor can generally bring more to the table than an individual franchisee.

Safety – Customer & Employees

The public and employees are naturally concerned about the possibility of being infected when meeting with other people. A careful review of the franchise agreement will identify opportunities where the franchisor can require franchisee compliance with Covid-19 policies for hygiene and sanitation. At a minimum, franchisors should require franchisees to comply with the CDC’s Guide for Preparing Workplaces for Covid-19

In addition to publicly supporting the application of government guidelines about hand-washing, hygienic mask wear, and social distancing in franchisee operations, franchisors should develop and promote public awareness of franchisees’ efforts to supply a “safe” environment for customers and employees.

Final Thoughts

Many franchise systems are fighting for their existence as a business, the survivability of their franchisee network being the company’s primary strategic goal. An effective Covid-19 strategy simultaneously addresses two audiences:

  • Affiliated parties. Franchisees and employees are especially stressed, worrying about losing personal assets and jobs. Franchisors should be aggressive during these times to promote their leadership and sense of community with franchisees. The effort might include a telephone or virtual “help” line to answer questions or direct to external resources.
  • External public. In addition to publicly promoting your products or services, your public messages should sustain your commitment to the brand and showcase support of your franchisees.

No one knows what they business environment will be like once the pandemic cools down. One thing is sure, there will be survivors, anxious to take advantage of the new environment. Taking actions to reduce the overall impact on the franchisee network may be the difference between emerging from the downturn in a healthy position, ready to take advantage of the new business environment, or having to rebuild..

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