International Franchising: Structuring the Relationship

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Approaches to Structuring International Franchise Relationships
Outside of the United States, franchisors use several different approaches to expand their systems. Commonly used methods include: (1) granting franchises directly to franchisees in the target country, (2) setting up a branch or subsidiary of the franchisor in the target country and having that entity grant franchises, (3) creating a separate legal entity with a "partner" in the target country and having that entity grant franchises and (4) granting master franchise or development rights to franchisees in the target country. Before selecting an expansion method, the franchisor should confirm that the laws of the target country permit the structure that the franchisor intends to use.  Often, the franchisor will use different approaches in different countries.

Direct Franchising
In this scenario, the franchisor grants a franchise directly to the franchisee in the target country. Franchisors most frequently use this method where the target country is geographically close to the United States, where the target country has customs, languages and legal systems that are similar to those in the United States and where training and ongoing supervision and assistance can be furnished on a cost-effective basis in the United States, in a country geographically close to the target country or in the target country.

Potential Advantages

• The franchisor does not form a legal entity in the target country, thereby reducing costs.
• The revenues collected by the franchisor are higher because the initial and ongoing fees are not shared with a third party.
• The franchisor maintains greater control over the appearance and operation of outlets in the target country.

Potential Disadvantages

• The franchisor might experience problems providing timely and adequate service and support.
• Slower system growth in the target country.
• It may be difficult to ensure a supply of proprietary items to franchisees in the target country.
• The addition of outlets in a foreign market may strain the franchisor's resources.
• Government approval and/or registration may be required for each franchise agreement. This process can be time consuming and costly.

Branch or Subsidiary
If a franchisor establishes a branch or subsidiary in the target country, the branch or subsidiary acts as the franchisor in the target country and is responsible for granting franchise rights to franchisees in that country. A franchisor should use this technique only if it has adequate capital and management resources to dedicate to the branch or subsidiary in the target country. The franchisor should bear in mind that the branch or subsidiary will be responsible for franchise services in the target country, including recruiting, training, site selection and site development, marketing and other administrative functions. Qualified management personnel must reside in the target country to manage the administrative offices and implement the franchise system.

Potential Advantages

• The franchisor will have greater control over franchising activity, including the use of trademarks, proprietary information and other intellectual property.
• The franchisor will collect higher revenues because the initial and ongoing fees are not shared with a third party.
• The office and other facilities in the target country will create a stronger presence.
• If the target country has limitations on currency conversion, the presence of franchisor-owned facilities in the target country can facilitate currency conversion.

Potential Disadvantages

• The franchisor must commit significant financial and management resources to set up an office and other facilities in the target country.
• The franchisor must ensure compliance with laws, customs and business practices of the target country.

Joint Venture
In a joint venture arrangement, the franchisor and a "partner" will form a separate legal entity. That legal entity will grant franchises to franchisees in the target country. Typically, the partner is an individual or business entity located in the target country. Franchisors commonly use joint ventures if the business is relatively unknown or if the market for the products or services is uncertain. In terms of the contributions of each party to the joint venture, generally, the franchisor contributes the franchise system, the proprietary information and intellectual property; the partner contributes money, expertise in operating a business in the target market and knowledge of the laws and customs of the target country.

Potential Advantages

• Since costs are shared between the franchisor and the partner, the parties share the risk of loss.
• The partner has local market expertise, including knowledge of local customs and tastes and valuable business and political contacts.
• By having an ownership interest, even though shared, the franchisor has greater control over the development of the franchise system in the target country and the use of its trademarks.

Potential Disadvantages

• The franchisor and the partner share the initial and ongoing fees, profits and other benefits.
• There is a risk of ineffective management by the partner, disagreements with the partner and diffusion of authority.
• The creation of a joint venture requires a large investment that may be vulnerable to currency conversion limitations and political instability.

Master Franchise/Development Rights
Franchisors utilize master franchise agreements and development agreements to establish a number of franchise outlets, simultaneously or successively, within a substantial geographic area during a defined period of time. When the parties enter a development agreement, the franchisor grants to the developer in the target country the right to establish and operate multiple franchised outlets. The developer will directly own the franchised outlets that are established. If the parties enter a master franchise agreement, in addition to granting the master franchisee the right to establish and open franchised outlets, the franchisor also grants to the master franchisee the right to grant subfranchises to third parties to establish and operate franchised outlets within the designated geographic area.

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A master franchise agreement enables the franchisee to expand more rapidly than a development agreement. In a master franchise relationship, however, the franchisor's control over its franchise system, including its trademark, may be diminished. In addition, the franchisor may experience practical difficulties dealing with subfranchisees upon termination of the master franchise agreement. Since a developer will develop the target country itself, a franchisor choosing this approach must find a franchisee with adequate capital and management resources to satisfy the development obligations.

Potential Advantages

• The franchisor commits fewer financial and management resources.
• The technique permits rapid market penetration and system growth.
• Generally, more sophisticated investors will be attracted by these arrangements.
• The costs to enter the market are significantly less even if the language, culture, customs and laws are different.

Potential Disadvantages

• If the franchise is relatively unknown in the target country, if the goods or services offered are not well-developed in the target country or if the franchised business will face significant competition in the target country, the developer or the master franchisee may have difficulty meeting the development schedule.
• If a master franchise relationship is used, the franchisor will receive less revenue because most fees will be split between the master franchisee and the franchisor.
• The franchisor's control over the franchised system in the target country will be diminished.
• There is a risk of "breakaway" franchisees in the target country.

For more information about international franchising and development, please contact Franchise Group Chair Bob Smith at 202.719..

This is a publication of Wiley Rein LLP and should not be construed as legal advice or a legal opinion on any specific facts or circumstances.  The contents are intended for general informational purposes.  You are urged to consult your lawyer concerning your own situation and any specific legal questions. 

When an American based brand decides to start selling franchises internationally, there are a number of decisions that must be considered first. Because of the complexity of this significant business move, speak with an attorney about international franchising. Our team could address any questions you may have and explain what you should think about prior to expanding internationally.

Determine the Legal Requirements for the Country of Expansion

Although not all countries have franchise laws as stringent as the United States, many countries have franchise relationship laws that must be complied with prior to offering or selling franchises in that country. Some of these laws may require a modified franchise disclosure document or no disclosure document at all. Many of these countries also require that the franchise agreement be translated into that countries native language. Franchisors in foreign countries must be aware of all of these aspects of franchising, which necessitate the need for an attorney in that country which and, in turn, are accompanied by a legal bill. Franchisors looking to sell internationally should expect legal bills approximately the same as what it took them to franchise in the United States.

Is there Foreign Interest in the Franchise?

An important question to address before franchising internationally is whether there has there been any interest in the franchise from a specific country. Many brands started franchising in the United States because someone approached them with interest in buying a franchise. A franchisor may also ask themselves why expand into another country at this time, is there someone interested in purchasing the rights to the entire country, and is there a sales team capable of soliciting franchise sales in the country?

Is the Brand Strong Enough?

When mini brands franchise internationally, they do so under one of two circumstances. In one instance there is a brand that is well known throughout the United States and has saturated or almost completely saturated the United States and therefore expands internationally to broaden the global footprint of the business. On the other hand, a franchisor may have a business that is younger and has only a few locations within the United States, but was approached by somebody from a foreign country with interest in bringing that brand to their country. In the first instance, the franchise brand may be strong enough to stand on its own with possibly global recognition of the system name or logo. In the second instance the franchisor must understand that their brand may not be recognizable at all within that foreign country, and as a result, substantial marketing efforts may be necessary to grow the brand within that country. They may have to use tactics similar to those used in the United States when the brand was first franchised.

Securing Intellectual Property When Franchising Internationally

Although a trademark is federally registered in the United States, it may not have any protection in other countries. Before expanding a franchise to another country, a franchisor should retain an intellectual property attorney that is familiar with the laws of the country to determine whether a trademark is already registered in that country. If not, a franchisor may not be able to expand into that country using their existing trademark. Also, although a trademark may be available in that country, a franchisor should determine if their trademark is culturally appropriate within that country. Many words, phrases, logos, and images used within the United States may have secondary meanings in other countries or may be seen as derogatory or offensive. It is important to determine this before franchising internationally to avoid any public relations issues.

Although it is tempting to go into a foreign country to expand franchise sales and bring in more revenue, without a proper game plan for that expansion a franchisor could be wasting time and money. If you have more questions about franchising internationally, our team is here to help start this process.

Are you interested in learning more about international department store franchise? Contact us today to secure an expert consultation!