UK: Joint Venture Franchises: The Whys And Wherefores

Last Updated: 1 August 2018
Article by Gordon Drakes and David Bond

Franchising provides a flexible model for growth or re-engineering, with a variety of structures to meet different needs. Of all the structures the joint venture franchise is the least understood and most likely to cause difficulties, if not structured correctly. In order to understand why this is so, it is necessary to consider the rationale for using the joint venture model and the manner in which the relationship should be structured.

1. What is a joint venture franchise?

From the outset, the name itself is misleading. It implies that the joint venture and franchise are one and the same, often documented within one legal contract - a joint venture franchise agreement. That perception is the root cause of many problems encountered with this model. A "joint venture franchise" is shorthand for the grant of a franchise to a joint venture party.

2. Why would a Franchisor adopt a joint venture model?

There are many reasons why a franchisor might consider adopting a joint venture structure but they often involve two, diametrically opposed, objectives. Either the franchisor wishes to exert greater control over the franchisee or it wishes to show greater commitment to the franchisee, by committing its own resources to the franchise.

The controlling franchisor

In a traditional franchise model the franchisor relies on the contractual terms within the franchise agreement to control the franchisee. This control often extends beyond the manner in which the franchisee operates the franchise business and touches upon the franchisee's access to working capital, the identity of directors/shareholders and their other business interests and typically creates consequences if there is an unapproved transfer of shares in the franchisee. This level of control is often sufficient for franchisors, representing the right spot on the risk/reward graph.

However, for some franchisors this contractual control is not enough and they want the added influence provided by a joint venture. With a joint venture franchise the franchisor maintains its contractual control through the terms of the franchise agreement but this is underpinned by a further layer of control at a corporate level, through the joint venture or shareholder arrangement. By taking an equity interest in and possibly a seat on the board of the franchisee company the franchisor can influence, and potentially direct, the conduct of the franchisee business. This influence can extend to all aspects of the franchisee's internal operations including recruitment, site selection, business planning and pricing.

The nurturing franchisor

In contrast, franchisors may adopt the joint venture model simply to provide greater assistance to the franchisee. This assistance can take a number of guises but is typically the injection of capital in return for an equity stake. The capital might be paid in cash or simply a waiver of the initial franchise fee, allowing the recruitment of young, enthusiastic franchisees who might otherwise struggle to raise the necessary capital to invest in the start-up of the franchise. By taking an equity stake the Franchisor is showing its own commitment to the franchisee's business, the franchisor has "skin in the game".

Other reasons behind joint ventures

There are other factors that may influence the decision to adopt a joint venture model including:

  1. Legal necessity - there are certain jurisdictions that require a franchisor to open and operate its own corporate units before it can set up a pure franchise network. Setting up a joint venture with a potential franchise partner can allow the franchisor to comply with this requirement but still press ahead with an entry into the market;
  2. Testing a market - from a franchisor's perspective, there is a strong temptation to convince potential international franchise partners that the franchisor's domestic concept is immediately transferable to another country without the necessity of setting up a pilot or group of pilot locations. A joint venture can be used to test the concept in a new market before employing a pure franchise model.

However, perhaps the most common reason in current times to use a joint venture model is for the purposes of a future strategic buy-out.

3. Strategic Buy-out

A Strategic Joint Venture can be used as a sequenced market entry strategy by which the franchisor agrees that it and a franchise partner will together set up a "special purpose vehicle" to act as the franchisee to establish the franchise business (under the terms of the franchise agreement granted by the franchisor) with the stated aim that the franchise partner would transfer its interest in the special purpose vehicle to the franchisor in due course at a pre-agreed formula based price.

In return for the franchise partner making the requisite investment in the franchisee business the franchisor allows it to participate in the generation of a strong income stream with a predetermined fixed-term exit strategy on an agreed valuation coupled with a release of its written down capital investment.

This buy-out structure can, of course, be attempted by way of a contractual provision in the franchise agreement. However, this often causes confusion in the negotiations and a lack of clarity on the final agreement. It also results in the acquisition of a company that has not been operated with the franchisor's input and therefore is not culturally attuned to the franchisor's expectations and so becomes difficult to integrate into the group.

The key difference between a Strategic Joint Venture and the many other types of joint venture franchise is the level of control and day to day involvement of the franchisor in the management of the franchisee. Strategic Joint Ventures tend to require more involvement of the franchisor whereas other structures are designed for minimal day to day involvement from the franchisor.

4. How to structure a joint venture franchise

No matter what the purpose behind adopting a joint venture model, the structure should be broadly the same. There should be a two layered relationship between the franchisor and its franchisee.

The first layer is the contractual "franchise" relationship under which the franchisor grants the franchisee the right to operate the franchised business. The terms of this relationship are governed by the franchise agreement.
The second layer is the "equity" relationship under which the franchisor takes an equity stake in the franchisee, in return for giving some value to the franchisee (such as a waiver of initial fees of a capital investment). The terms of this equity relationship are governed by the shareholders' agreement, often referred to as a joint venture agreement or a subordinated equity agreement, because the equity control is subordinate to the primary contractual control.

The following diagram illustrates a typical joint venture structure.

5. Key issues in joint ventures franchises

When embarking on a joint venture, it is best to keep the following best practice tips in mind:

(a) Avoid conflicts of interest

Above all, the franchisor must distinguish between its role as franchisor and its role as a shareholder in the franchisee. There is an inherent conflict of interest between the two roles and a failure to separate those interests brings significant risks. This is particularly true within a Strategic Joint Venture where the franchisor is likely to have a representative on the franchisee's board.

It is not hard to imagine situations where the franchisor can be exposed to unacceptable levels of risk through its exercise of shareholder or board influence over the franchisee. Examples include making decisions on employee recruitment and dismissals within the franchisee (raising fears of the franchisor being a joint employer) or pushing through system-wide changes required by the franchisor without due regard to the impact on the franchisee.

One of the most effective ways to maintain this separation of interests is to ensure the two layers of the relationship are maintained – the franchise agreement and the joint venture agreement.

(b) Duty of good faith

A growing line of UK authorities have held that a duty of good faith could be implied into ordinary commercial contracts and whilst it should not be implied by default, it is more likely to be implied into "relational" contracts – i.e. long term commercial relationships which require a high degree of trust and cooperation, like franchise agreements and joint ventures.

In the recent case of Nehayan v Kent [2018] EWHC 333 (Comm), Lord Justice Leggatt noted that whilst "the parties to the joint venture were generally free to pursue their own interests and did not own an obligation of loyalty to the other, it would be contrary to the obligation to act in good faith for either party to use his position as a shareholder of the companies to obtain a financial benefit for himself at the expense of the other".

Whilst this ruling by no means provides that all joint ventures will contain an implied duty of good faith, when entering into any form of joint venture the franchisor should be careful that its actions are not contrary to the principles of good faith. The franchisor should control and reduce this risk through careful contractual drafting.

(c) Maintain separate agreements

All of the operational controls should be maintained through the franchise agreement. Duplicating or repeating similar or related items in the joint venture agreement should be avoided. In fact, the franchise agreement used with a joint venture franchisee should really be no different from the franchisor's standard document.

(d) Cross-default

Termination of the franchise agreement should automatically lead to the winding up of the special venture vehicle. The opposite is also true, if a deadlock arises within the special purpose vehicle then most likely the franchisee will be unable to operate. Certainly relations between the franchisor and franchise partner will mean that it would be preferable if the franchise partner was no involved in the franchise network.

(e) Foreign Direct Investment/Tax

In some countries the franchisor cannot own more than 50% of the shares in the franchisee company. In these cases, ensuring the franchisor has control under the franchise agreement is even more essential.

However, it is important to take local advice on the structure to ensure that by becoming a shareholder in a local company with a seat on the board, the franchisor and/or and its directors are not exposed to onerous tax liabilities, or other types of personal and fiduciary duties.

6. Conclusion

Joint venture franchising is a dynamic but complex commercial model that can be used to achieve a variety of strategic purposes. It is important that both the franchisor and the franchise partner understand each other's objectives and devise a version of the model which is aligned with those objectives. The more the parties invest in the planning and structuring stage, the more likely that the joint venture will deliver long term success for both the franchisor and the franchise partner. Above all, it is crucial that the franchisor's roles are clearly delineated and that the two layers of the relationship – the franchise and the joint venture – are kept distinct.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Gordon Drakes
Similar Articles
Relevancy Powered by MondaqAI
Charles Russell Speechlys LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Charles Russell Speechlys LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions