United States: Hotel Franchise Agreements And The 5 Biggest Mistakes A Hotel Owner Can Make

Last Updated: October 4 2011
Article by Robert E. Braun

Previously published in Hotel Online, HOTELS and Hospitality Net

Hotels need brands, and brands need hotels. For many years, hotel brands have been growing in importance for the success of hotels in the United States and abroad. The trend toward branding is quite a phenomenon. According to numbers we have seen, In the early 1990s, approximately 40% of the hotels in the U.S. were branded and the balance were independent. Now the number is probably closer to 80% or more of the hotels are branded or brand-affiliated.

The branding is often accomplished by a franchise or license agreement from a company owning the brand. Other times it is accomplished by a branded hotel management company entering into a management agreement with the owner of the hotel, providing both the brand and management for the property.

Although we have spent a lot of time on Hotel Law Blog discussing hotel management agreements, today we are going to focus on the franchise or license agreement arrangements. With more than 20 years' experience working with more than 1,000 hotel management and franchise agreements, we have some perspectives that may be worth considering.

Hotel owners keep falling into the same traps.

One of these perspectives of our hotel lawyers is that many sophisticated hotel investors and owners seem to fall into a handful of traps that would be easy to avoid. And this same handful of traps catches the unwary time and again.

So this article focuses on hotel franchise agreements and outlines the 5 biggest mistakes an owner can make when seeking a hotel franchise arrangement. If this sounds all too familiar, you have probably learned these lessons the hard (and expensive) way. If you haven't stumbled on these yet, you won't want to miss the warning flags and the traps they portend.

Hotel Franchise Agreements: The 5 biggest mistakes a hotel owner can make

By Robert E. Braun | Hotel Lawyer, JMBM Global Hospitality Group®

Over the years, we have found that hotel owners get into bad situations with their franchisors because they fall into one or more of a handful of traps for the unwary. While there are many issues facing franchisees, the following are what we think might be the 5 biggest mistakes owners make when deciding on a franchise for their hotel, and the "famous last words" that accompany them:

Mistake #1 :Focusing on just one brand and letting them know you "have" to have them.

Famous last words: "I just have to have [name of brand] for my hotel - they are perfect!

Even if the brand is perfect, the best way to get a great brand and a fair deal is to make sure there is competition, compare the results, and make sure each brand knows there is at least one other brand to "meet or beat." The process isn't an auction, but it is a controlled, selective competition that brings out the best deals from the brands and gives the owner the best choice.

Mistake #2: Trying to do it yourself - it's a false economy. You don't know what you don't know.

Famous last words: "I met some great franchisors at a hotel conference last week, and they love our project and said they'd bend over backwards to make me a good deal. I don't really need any help, all I need are a couple of phone numbers to call."

Finding a good brand is intentional, not accidental, and drawing out the best business and legal terms in a franchise takes someone who has been there before. Hotel executives make their living by negotiating hundreds of deals with amateurs. Unless you identify the real issues and realistically approach your project and its needs, your deal will get shopworn and tired before it is positioned. And if you let the franchisor drive the process, you are likely to find yourself with a letter of intent or term sheet before you have identified your needs and shaped the conversation.

Mistake #3: Starting the process by getting proposals from the brand to save time and money.

Famous last words: "Let me get the letter of intent signed -- it's non-binding, anyway. I'll bring in the experts when we negotiate the franchise agreement."

For all intents and purposes, the letter of intent is the final agreement - unless you identify the points of negotiation, virtually every franchisor will demand that you sign their franchise agreement as-is. Franchise agreements are not like other commercially-negotiated agreements; franchisors demand uniformity and making changes, even changes which make business sense, must be identified early. It is true that letters are generally non-binding, but the only alternative to agreeing to the franchisor's terms is often to walk away from the agreement, typically forfeiting a substantial (often six figure) application fee!

Mistake #4 - Believing that the franchisor's interests are aligned with yours because they make an investment in the property.

Famous last words: "We and [name the brand] have the same interests - they are giving us key money to get the deal."

It is gratifying when a franchisor offers to help fund your project. However, their needs are never fully aligned with yours. Franchisors almost never have money at risk; instead, they provide "key money - forgivable loans - or credit enhancements which amortize over the life of the franchise. Franchisors can get their money back if you try to terminate the franchise, or default, or for a variety of other reasons, and their "investment" is often backed by a personal guarantee. Moreover, the relatively small amount of key money comes at a high price, typically a longer duration, more onerous terms, and less flexibility. Finally, an owner must always understand that the interests of brands always diverge from the interests of owners. Owners are concerned about the health, well-being and profitability of their individual property, while the brand is concerned about the value of the brand, regardless of the performance and value of the individual hotels in the chain.

Mistake #5: Relying on a third party manager to protect your interests.

Famous last words: "I have a great operator for the hotel - they will negotiate with the brand and make sure I get a fair deal."

Third party managers can help, but they are as interested in pleasing the brand as they are in pleasing the owner - in fact, franchisors typically require that the manager acknowledge that the franchise agreement overrides the management agreement! The principals and operators in management companies often are drawn from the ranks of the brands, and they get a substantial part of their business from the brands, and their loyalty can be diluted. The manager can help, and in particular can help comply with the franchise, but if there is a problem, the owner stands alone.

How to Avoid these Mistakes

Brands and owners need each other. While tension always exists in the relationship, if they share the same vision, they have a better chance of a successful relationship. On the other hand, when an owner enters into a franchise agreement without understanding its ramifications and without creating a level playing field, the likelihood of success is limited at best.

How do you achieve this balance?

To reach an agreement that is successful for both the brand and the owner, there must be parity in the process. Owners need the same level of legal representation that the franchisor will have. The franchisor's lawyers will have negotiated hundreds of these agreements. Your lawyer should have this level of practical experience, as well. The franchisor's lawyers will understand the implications and ramifications of each sentence and phrase in the agreement. So should your lawyer. The franchisor's lawyers will make sure the franchisor takes as little risk as possible -- that's the lawyers' job. Your lawyer should do the same job for you.

Over the years, JMBM's Global Hospitality Group® lawyers have negotiated hundreds of franchise agreements. We assist owners in identifying their goals, reviewing and prioritizing their needs, and pinpointing the brands that are most likely to match those needs. We recognize the inherent limitations in franchise agreements, and advise not only as to the potential terms, but the likely terms and how owners can balance their needs with the limits of the brands. We are a known quantity to franchisors and bring additional credibility to the deal.

Negotiating a hotel management or franchise agreement is one of the most important things hotel owners will ever do for their hotel investment. We can help.

You will find a lot more valuable information related to this topic on the Hotel Law Blog under the Topic hotel management and franchise agreements.

Also see The HMA Handbook: Hotel Management Agreements for Owners, Developers, Investors and Lenders.

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.

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