Lewis Cohen - partner in the Intellectual Property Group at Mishcon de Reya... International Expansion: An alternative to going it alone...
Replicating a successful business overseas can be a real headache. There are many success stories of British businesses that have grown large international operations but the media is also littered with stories of thriving British businesses that, despite having sunk substantial time and resources into the enterprise, have failed to transplant their businesses into international markets. There are many reasons for such failures; lack of market knowledge and experience, failure to understand and deal with cultural differences, language barriers and failure to establish successful supply/distribution channels and other critical networks are often key contributors.
US businesses have grown global operations using franchising for many years and many UK businesses are now following suit. The popularity of international franchising has intensified in recent years as businesses struggle to access the funds to facilitate an international expansion programme or prefer, in view of current conditions, not to use their own funds. In some countries, particularly in the Middle East, businesses cannot be owned by foreigners and therefore franchising may be the only viable option for establishing operations in those countries.
Particularly attractive features of franchising include using other people's resources to fund overseas expansion and having that expansion driven by businesses with a successful track-record of operations in the local market, tried and tested networks and distribution channels, an intimate understanding of the culture and language plus access to key real estate.
As a lawyer specialising in international franchising, I get a lot of approaches from companies that have received offers from potential overseas partners. These can be very exciting and flattering but I always caution my clients, especially owner-managed operations, to evaluate carefully whether now is the right time for their overseas development or whether it will distract them from better opportunities or other priorities. It is easy to get carried away with the chance to grow internationally but it is crucial that the same rigorous analysis of the opportunity, resources and time needed to make it a success are applied as they would be to any other venture. Ego should not get in the way! For example, it might be that there are better opportunities elsewhere or that the proposed partner does not have the resources or experience to be successful.
The time and resources needed to make a success of international franchising are often underestimated; to find the right partner, to protect IP in overseas markets, to draft and negotiate substantial contracts, to convey how to operate the business correctly (usually through the contract and the provision of an operations manual and training), to approve locations and fit-outs, to provide on-going support and to monitor performance closely is no quick feat. Making a success of international franchising always costs more and takes more time than clients expect and the expectation should almost always be that it is a long-term investment. Established businesses often have many of these capabilities in their business so it may be a question of deploying them effectively to support a franchise network and augmenting them with people with franchising expertise. However, smaller businesses could find that the process drains resources that could be better spent elsewhere.
There are a multitude of legal issues that need to be considered in any international contract and this is, of course, true for international franchise agreements. Issues include:
• A number of countries have specific franchise laws designed to protect franchisees. For example, in the US these apply on a Federal level but a number of States have also enacted their own laws. These can require extensive pre-contract (and annual) disclosures and/or registrations. Compliance with these laws can be very time consuming and costly but there can sometime be ways of structuring the franchise development to circumvent the laws;
• In some countries, again notably in the Middle East, franchisees are considered to be agents and laws designed to protect agents can apply to franchisees. These laws can have a nasty sting in the tail for franchisors; they can make it challenging to walk away from a franchisee and substantial compensation may be payable to the franchisee on termination or expiry. Careful structuring of these arrangements is crucial and can pay dividends;
• Enforcement of English court judgments. Not all countries recognise English court judgments and will enforce them. It is crucial to consider whether your agreements will be enforceable and how easy it will be to do so. When English court judgments are not enforceable, arbitration can sometimes provide an effective alternative if the target country has signed up to a convention under which it has agreed to enforce arbitral awards. This can also sometimes be a useful method for avoiding the local courts applying overarching local laws (see below);
• The applicability of foreign laws. Some countries have laws that will apply to the arrangement regardless of what is in the contract. This need to be understood and addressed before any contract is signed. Typically these cover a very broad range of issues including how to execute the agreement, terms that will be implied into the contract and terms that will not be enforceable in the country;
• Competition laws – franchise agreements often include exclusive territorial rights, controls and restraints which could fall foul of local competition laws and should be checked for compliance;
• IP protection – key considerations are whether the franchisor has protected its IP in the target country and how do the local courts enforce IP rights. Anyone thinking of growing internationally should check whether anyone else has got IP rights in target territories that could prevent expansion – keeping an eye on this is cheap and should always be done. A number of businesses have found themselves locked out of key territories for failing to adequately protect their IP or stopping others from hijacking it in overseas markets;
• Tax – the franchisor will need to consider how the arrangements will impact on its business. Franchisors often receive royalty payments and sometimes the franchisee is required to deduct local taxes before paying the franchisor. These issues should be investigated before the deal commences and steps taken to ensure that the franchisor will receive the funds it is expecting.
This non-exhaustive list of issues illustrates the diligence needed when embarking on overseas expansion through franchising. Notwithstanding the business and legal issues, there is no doubt that when done at the right time, with the right partner, in the right market and with the right infrastructure international franchising can provide a business with excellent long-term rewards.