Franchise Network Joint Venture: An Interesting Solution for Network Development

Following two focuses (Food and Health & Beauty), this month I would like to focus on a critical aspect common to all franchising realities: the difficulty in closing affiliation contracts. Considering the complexity of aspects, I will focus on a couple of fairly common points, especially in the food sector, starting, as always, from a real case. Let’s start with the case summary.

The case

A restaurant format in Rome with several direct points decides to launch a franchising development project, structuring an affiliation offer adhering to the direct realities for menu proposals, initial investment, and operational model.

Critical Point: High Set-Up Cost

It is known that if a format is not already strong from a brand perspective, finding investors and/or affiliates willing to invest significant amounts is not easy. Indeed, during the launch phase, the ownership had difficulty closing contracts, not because it was not appreciated, but due to the poor financial capacity of the franchisees. The most widespread obstacle to affiliations, along with the limited availability of truly suitable locations. The format had presented itself to the market in a rigid manner with a total investment cost exceeding 150,000 euros. The franchisor absolutely did not want to compromise its business model, nor to find compromises between operational needs and initial investment. The franchisor was adamant about wanting to replicate only its original model, and no other format declination would be accepted. However, even though opposed to a different scalability of its format, it seemed to us that it could have attracted more investment in exchange for some certain affiliation results.

Solution: Joint Venture Affiliation

After collecting project information and feedback from brand interested parties, we evaluated the proposal of joint venture affiliation as a viable option in this initial phase. Why? In this way, the parent company is directly involved in the openings with the respective affiliates who can count on the direct involvement of the parent company in the openings.

What does it consist of? The Parent Company, together with the affiliate, establishes a NEWCO company that will affiliate with the brand. The agreement may involve mutual investment from both parties, or a division of responsibilities (organizational responsibility on the part of the Parent Company and financial responsibility on the part of the Affiliate), or a real division of the investment cost. Such a joint venture demonstrates that the Parent Company believes in the project and is ready to take all the associated risks together with the affiliate, who will play a managerial role. In this specific case, we hypothesized two possible scenarios that do not exclude each other but can be applied based on the circumstances of the negotiation.

This approach has already defined the first two affiliation contracts, allowing to unlock the development plan that seemed to have stalled.

Scenario A

A NewCo is established for the opening of the affiliated point of sale. In this case, the affiliate becomes the majority shareholder in exchange for the realization of the fee and royalties. In other words, in exchange for the entire investment cost, the majority of the company shares are given, and fees and royalties are eliminated. The parent company participates as a minority shareholder, foregoing these considerations and operating concretely as an operational partner providing know-how, training assistance, managerial, and operational support. Furthermore, the Parent Company, with a shareholders’ agreement, can reserve the possibility of an exit: i.e., sell its shares to the affiliate partner at the current market value. In this way, the parent company can monetize its investment represented by skills and operation. On the other hand, the affiliate becomes the sole owner, restoring a pure affiliation situation.

Scenario B

A solution, we could say, “inverse”. The parent company enters the NewCo with 51% as a financing partner (thereby participating in the opening and setup expenses), foregoing fees and royalties in exchange for a larger share of the company’s profits.

In this way, the affiliate is certainly relieved of initial costs but would serve as a minority shareholder (either financial or operational). For the parent company, we recommended, this type of option is preferable to be applied only for entry into cities of interest, as it presupposes direct financial involvement in the NewCo. Therefore, it needs to be carefully evaluated and only in certain favorable circumstances (not least the reliability of the affiliate). In this case too, a shareholders’ agreement can be signed for an exit strategy. The agreement may provide for a dual exit right, one for the parent company and one for the affiliate. The parent company sells and monetizes its shareholding at the current market value, giving the affiliate the opportunity to become the sole owner, thus restoring the pure affiliation situation. If the affiliate exits, they monetize the investment, and the parent company will transform the hybrid affiliate point into a direct point in an area of strong commercial interest.