Foreign franchisors entering the U.S. market
Foreign companies often begin doing business in the U.S. by distributing or licensing their products or services in the U.S. Sooner or later, many companies form a U.S. subsidiary to operate the U.S. business. Franchise companies may form a U.S. subsidiary to operate the U.S. franchise business, or they may appoint a master franchisee to handle that business.
The entity that most foreign companies use when they form a U.S. subsidiary is a corporation. Corporations are established in the U.S. under the corporate laws of one of the fifty states. Most businesses form the corporation in the state in which they will locate their U.S. office. The corporation can then operate anywhere, but if the company intends to establish offices or warehouse facilities in another state, it may be necessary to seek formal authority to do business in that state.
One way to enter the U.S. market is to test the concept by setting up a functioning business through either a subsidiary or a single franchisee. The single franchisee may eventually become a master franchisee for the entire U.S. market, but only after the business is proven and the master franchisee itself has demonstrated its ability to succeed.
While a single master franchise agreement is typically an international agreement between the foreign licensor and the U.S. licensee or master franchisee, the individual franchise agreements (or multi-unit agreements) are usually between two U.S. entities.
The entity that sells the franchises in the U.S., the “franchisor”, might be a wholly-owned subsidiary of the foreign brand-owner or it may be an independent or jointly-owned master franchisee. This entity must prepare a franchise disclosure document and must register its franchise offering with the appropriate states. Whether this entity is a subsidiary or a master franchisee, its disclosures must include audited financial statements prepare in accordance with U.S. generally accepted accounting principles. The financial statements must be audited by an independent certified public accountant using generally accepted U.S. auditing standards.
The fact that a foreign franchisor has experience franchising outside the U.S. is helpful in structuring the system for the U.S. launch. However, the U.S. market is radically different from that of most countries. Franchise agreements and offering documents prepared for use in other countries typically must be substantially rewritten to meet U.S. legal requirements and market expectations.
While the U.S. market has regional and local variations, in many ways it can be viewed as a single market for a franchise company. The market should be managed from a central source. It is not a good idea to appoint different master franchisees in different regions of the country. Appointing different franchisees in different parts of the U.S. makes the master franchise agreement itself a franchise, with the resulting registration and disclosure requirements. Moreover, the company that grants the master franchises will be viewed as a franchisor, and each master franchisee will be viewed as a “subfranchisor”. The franchisor and subfranchisor will be jointly liable for compliance with the franchise laws. The unit franchise disclosure document must include disclosures about both companies, including the audited financials of both the franchisor and the subfranchisor.
It makes far more sense to enter the U.S. market in one geographic area (or a small number of areas) and to expand gradually as the brand becomes successful. A more aggressive approach that might work would be to appoint multi-unit area developers in different parts of the U.S., but not to allow them to subfranchise.
One final note: An important preliminary consideration for any foreign franchise company entering the U.S. market is trademark registration. The brand should be registered with the U.S. Patent and Trademark Office.
U.S. franchisors expanding abroad
A U.S. franchisor is most likely to succeed internationally if the franchisor:
- is successful in the U.S. and is seeking to build on that success abroad, rather than to export a concept that is untested or unsuccessful in the U.S.;
- has made an informed decision on which country to enter, has studied the destination market and is confident that the business can be tailored successfully to meet the peculiarities of that market;
- has carefully selected the best available contract partner or partners in the destination country; and
- is prepared to make a substantial commitment of personnel to service and support the foreign market.
The geographic, cultural and linguistic distances separating the franchisee from the franchisor are reasons to devote more energy to the relationship, not to sit back and expect the revenues to grow. A company can maximize its chance of success by actively planning its venture abroad and committing real resources to that venture. International growth does not happen by itself. Passively accepting an unsolicited offer from a foreign company is not a substitute for a business plan. Raising cash by selling country rights and doing nothing more is not a plan for success.
The role of a U.S. franchisor’s U.S. lawyer in international franchising is to be the principal drafter of the international agreements and to coordinate work with local counsel in each destination country.
A U.S. franchisor should prepare a form of master franchise agreement and a form of unit agreement that the master franchisee will sign with unit franchisees in the destination country. In place of a master agreement, the franchisor may prefer to enter into a multi-unit agreement with a single company abroad that will open its own company-owned units rather than franchised units.
Before any draft is given to the prospective contract partner abroad, the draft agreement should be reviewed by local counsel in the destination country. In fact, it is a good idea to consult with local counsel before serious discussions with any prospect begin. Advance knowledge of the destination country’s legal and tax requirements will put any U.S. company in a good bargaining position. Knowing the costs of compliance in advance will also help in determining the right level of initial fee and ongoing royalty.
Trademark protection in the destination country is one of the very first issues to arise. Is the trademark available in that country? If so, does it make sense from a marketing point of view in the language and culture of the country? And can it be protected there?
Unless a company protects its trademarks in the destination country, the company may find that its marks infringe the rights of another trademark owner in that country. The company will then be faced with the prospect of either being required to litigate its rights, purchase the mark from the foreign owner or sell under a different mark. The result can be that the company is required to use different brand names in different countries.
Another possibility is that the mark may be unavailable in the destination country because someone else has already registered it. Before launching a business abroad, the company should have a search firm do a full trademark search to be sure that the trademark will not infringe the rights of anyone else. If the search results indicate that the mark is available, the company should seek trademark registration in the destination country.
Trademark registration abroad is especially important abroad because trademark rights in most countries are based on registration and not on use. The first to register is the one who has the rights.
Any number of laws also come into play in international franchising. Some countries require international license agreements to be registered, and the franchise agreement may need to be translated. Trade secrets may be difficult to protect in some countries. Exchange control requirements or technology transfer laws may limit or restrict the payment of royalties abroad. Withholding taxes may apply. Injunctive relief through the judicial system may not be available. Agency laws may make it difficult to terminate the relationship.
A growing number of countries also has laws that specifically govern the sale of franchises. In order to comply with these laws, some franchisors have prepared a “multinational” disclosure document that is based on the U.S. model but tailored specifically to the international setting and then modified for use in a specific country. Countries that have franchise laws include Canada, China, Indonesia and Mexico, among others.
U.S. laws may also affect the transaction, ranging from the New York Franchise Act to the Trading with the Enemy Act; from antitrust laws to anti-boycott laws and laws prohibiting corrupt business practices, money laundering or terrorism.
While franchise agreements are sometimes negotiated in the U.S., negotiation is likely to play an important role in international franchise agreements. A well-drafted and seriously negotiated agreement will hopefully lead to profits for both parties and minimize the likelihood of disputes later on.