What's in a name?

Bonaparte was wrong. Britain is not a nation of shopkeepers – it is a nation of franchisers. In 2000, the estimated annual turnover of the business format franchise sector in the UK was £9.3bn – up from £0.9bn in 1984 – and with an average turnover per franchised unit of £289,000.

Not bad for a sector that, until the late 1970s, “was regarded in some quarters as another name for pyramid selling, and therefore something to be a little suspicious of”, according to Anton Bates, commercial partner at Owen White and legal adviser to the British Franchising Association (BFA).

“It's a very versatile tool,” says Mark Abell, head of the brands, technology and communications department at Field Fisher Waterhouse. “It has equal and yet different appeal for the small entrepreneur and the large multinational. On a scale of risk against control, you can have a lot of control but a lot of risk by setting up a subsidiary, or little risk and little control by using agents. Franchising gives you the best of both – considerable control but a reduced risk.”

At its most basic, franchising is the granting of a licence to operate a business under a particular brand, and benefit from the support, guidance and assistance of the brand owner and a network of similar franchisees. The most common franchises are known as business format franchises (BFF), which are relatively low-cost and smaller-scale operations, such as Dynarod, Prontaprint and Dolland & Aitchison, whose franchisees benefit from the expertise, buying power and advice of the franchisers. The franchisers themselves, however, can be enormous – McDonald's being the oft-quoted example. Variations on the BFF include hotel chains such as Holiday Inn, where the cost and scale are the differential, or regional rail operators and even regional broadcasting licences, whereby the franchisee does not buy the licence to benefit from a particular brand or support network, but merely the licence to provide a service.

More growth, however, almost inevitably leads to more problems, and according to John Pratt, managing partner at Pinsent Curtis Biddle in Birmingham: “We're busier on the franchise litigation side than on the commercial side – it's one of the relatively few areas of litigation that's booming.”

“It's generally a mismatch of expectations between the franchisee and the franchiser that leads to litigation,” says Abell. “Less often it's mismanagement on the part of the franchiser, or the franchisee gets greedy.”

The leading UK firms deal with the whole range of franchising work. The larger practices, such as Eversheds and Field Fisher, tend to do the more international deals, and these firms have led the market in franchising for several years. Until recently, Martin Mendelsohn of Eversheds was “Mr Franchise” and his team pre-eminent. His semi-retirement has left a large pair of shoes to fill, a job that has fallen to well-respected partner Chris Wormald. The firm has acted for the Swinton and The Body Shop franchisee groups and represented Alldays in the buyback of its regional operations.

Field Fisher has perhaps the largest dedicated franchising team in the UK. Abell heads the group and can call on a core team of 11 lawyers, including four partners. Although dealing mainly with large franchisers such as The Body Shop and Regis, Abell was instrumental in the high-profile franchisee deals that restructured the Pierre Victoire, Pizza Express and Athena chains. In the words of one US journal: “He invented the FBI (franchisee buy-in).”

The franchise agreement or contract is the starting point for all franchises, and forms the basis of the franchiser-franchisee relationship. Unlike a commercial contract, however, the franchise agreement is not normally up for negotiation. “The franchiser will have a standard contract that lays down the terms for joining the franchise network. In a way, that's fair; all the franchisees should be treated the same and everything in the contract is essential for protecting the business, and that's in the interest of the franchisees as well as the franchisers,” says Julian Voge, corporate partner at Brodies in Edinburgh.

Contracts are usually for an initial five years, followed by a right to renew. “You need that commitment on both sides,” says Voge. It is after the first five-year period that things can go wrong in the franchisee-franchiser relationship. “Sometimes a franchisee will think, 'Okay, I know how to do this now and I'm not going to pay the fees anymore', but that's not the deal. The deal is that you have to keep paying the fees,” he says. Even if a franchisee decides to leave the network, there is generally some kind of restrictive covenant to prevent them from setting up in direct competition.

“One thing that's different in franchising,” Pratt says, “is the number of misrepresentation claims we deal with. Franchisers sometimes oversell the franchise, understandably as it's their business; while on the other hand, the franchisees, if they fail, will always tend to blame the franchiser and bring a misrepresentation claim.”

The duty of disclosure on the part of the franchiser is a key part of any franchise negotiations and often forms the crux of future litigation. In the UK, unlike the US and France, for example, the franchiser has no statutory obligation regarding disclosure. According to Bates at the BFA, the duty of franchisers to disclose full and frank information is unquestionable, and the BFA obliges all its members to do so, but there is no statutory obligation. He explains: “The problem with disclosure laws is that they promote a minimum requirement, and that's fine if you're in a business where that minimum requirement is appropriate for your industry. But what's appropriate for a prospective Holiday Inn franchisee, for example, is entirely inappropriate for a prospective carpet cleaner.”

Voge believes the onus is on the prospective franchisee to make sure they receive all the requisite information before committing to a franchise, as with any other commercial purchase. “I'm not sure why franchising should be picked out,” he says. “If I wanted to buy a shop in the high street, there's no obligation of disclosure on the person selling the shop. It's up to me as the buyer to ask what I want to know – nobody's stopping you asking the franchiser, and that's part of what your lawyer should be doing.”

There is still some way to go before franchising in the UK reaches the balmy heights of the US, where 25 per cent of all sales are through franchises, but Pratt believes that there's still ample room for growth. “There are franchises for all sorts of people,” he says. “From a franchise like Dynarod for the bloke that goes out and rods drains, to white collar franchises.”

Franchising certainly has a lot of benefits – rapid, national expansion without massive capital input; low risk with significant control retained, effective branding and marketing – so how long before the first franchised law firm?

British Franchise Association/NatWest Franchise Survey

The annual British Finance Association (BFA)/NatWest Franchise Survey monitors the performance, attitude and opinion of the UK franchise sector.

Turnover

Estimated annual turnover of business franchise sector in the UK: £9.3bn, an increase of 4 per cent on 1999.

This continues steady upward growth from £0.9bn in 1984.

Franchisers

Number of active business format franchises: 665, an increase of 3 per cent on 1999.

73 per cent of franchisers operate an independent system; 19 per cent as a subsidiary of a parent company; 9 per cent on a master licensee basis.

The average length of time in operation is 7.9 years.

Franchisees

Number of franchised units is estimated at around 35,600.

Average sales per unit is £289,000, up from £278,000 in 1999.

5.8 per cent of units experienced some sort of forced closure, and 6.3 per cent were voluntary. The latter figure is the highest recorded and includes not only financial failures at 1.8 per cent, but also franchisees moving for personal reasons, such as retirement, ill health or finding permanent employment.

52 per cent of respondents operate on a sole trader basis; 22 per cent are partnerships; 25 per cent are limited companies.

1 per cent are unknown.

Average age of a franchisee is 44.

Profitability

95 per cent of franchises report a profit, compared with 70 per cent in 1990.

52 per cent claim to be highly or quite profitable.

Those definitely making losses accounted for 5 per cent.

Finance

Average initial outlay for setting up a franchise is £44,500.

Average ongoing management fee is 7.2 per cent of turnover.

Average advertising levy is 2.7 per cent of turnover.

48 per cent borrowed money to set up, down from the 55-60 per cent of recent years. 77 per cent of those borrowing were financed by a bank.

The average amount borrowed was £32,500, up from £31,200 in 1999.

Back from the brink – Pierre Victoire

At its peak in 1996, Edinburgh-based French bistro franchise Pierre Victoire boasted more than 100 franchised restaurants throughout the UK and was poised for a £14m flotation. Founded in 1988 by Pierre Levicky, a French chef working in Edinburgh, the franchise was based on the concept of a cheap yet innovative menu in the evocative atmosphere of a French bistro. The idea was a success, but Levicky's talents in the kitchen did not appear to stretch to the boardroom. The flotation never materialised and Levicky began to seek a private buyer. When none was found, Levicky's bankers, the Bank of Scotland, called in the receivers in mid-1998.

It was then that a group of franchisees from some of the more successful outlets, led by Simon Edwards and Richard Willis, began trying to find a way of retaining control of their operations. They turned to Mark Abell at Field Fisher Waterhouse and Richard Krajewski of KPMG Corporate Finance. The idea of a group of franchisees taking control of the franchiser, a franchisee buy-in or “FBI”, was pioneered by Abell when the Athena group of poster shops was sold to its franchisees.

The Pierre Victoire deal saw a consortium of 12 franchisees take control of 36 restaurants, about a third of the original network, in a £4m deal backed by the Bank of Scotland. The new chain comprised 14 restaurants owned by the consortium, three owned by the consortium's new company Voila, and 19 owned by franchisees who were not members of the consortium.