Freedom of Associations: Is 2016 the Year of Franchisee Activism?

The usual reason for forming an independent franchisee association is to address problems with the franchisor or other conflicts within the system. While the goal of the franchisees who banded together was to improve the system as they saw it, the relationship often was adversarial--at least initially, until the two sides discovered they had overriding common interests. These internal "family feuds" were the norm for decades, especially in systems where the franchisees were not making the return on their investment they'd expected, for whatever cause.

In recent years, however, the focus of franchisee associations has expanded to include external threats--from competition and the battle for market share, to what many currently perceive as a threat from governmental and regulatory bodies to the franchise business model itself. This alliance against a common, external "enemy" has driven the two parties closer together, much as the Japanese threat to the U.S. auto industry in the 1970s and 1980s drove the United Auto Workers to view GM, Ford, and Chrysler more as an ally than an adversary.

From the NLRB's 2015 stance on joint employment, to minimum wage mandates by states and municipalities and the Fight for $15 from the SEIU, to the ongoing fallout from the Affordable Care Act, these are tough times for franchising. Tough times make strange bedfellows.

Little Caesars

Like most franchisee associations, the Independent Organization of Little Caesars Franchisees (IOLCF) was formed during a period of adversity for the brand. "Times were not so good in the mid-'90s," says Todd Messer, who operates 18 Little Caesars in Little Rock. "Franchisees grouped together to see if we could improve our situation."

About 30 percent of franchisees in the Little Caesars system are IOLCF members, says Messer, who is seeking to increase membership in the association. "One way is to provide an economic benefit to members," he says. That's one reason the IOLCF joined the Coalition of Franchisee Associations (CFA) about 6 years ago. Specifically, he's looking at group purchasing to help franchisees save on costs and boost unit profitability. After all, no matter what the brand or industry, "We all use air conditioning, trash disposal, and alarms," says Messer, who is a CFA co-chair and on the organization's Strategic Planning Committee. "By working together we're able to bring some synergy to create savings and cost advantages."

A second reason was to have a greater effect on state and national laws and regulations that affect franchising by joining with nearly 20 other franchisee organizations to make their message heard by policymakers. "State and local representatives will listen more intently to the voice of thousands of franchisees, instead of hundreds," he says. This expanded voice means a greater ability to affect state and national franchise law--to the benefit of franchisees nationwide.

Since the founding of the IOLCF, relations with the franchisor have improved significantly as both franchisees and franchisor have learned to work together to rejuvenate the brand. Ironically, the success of the association in helping to turn the brand around may be one reason many franchisees have chosen not to join. "The Little Caesars system has been enjoying a good decade for franchisees," says Messer. "Generally these associations are born in times of adversity. In good times it's harder to bring people together."

Although franchisee-franchisor relations are vastly improved from 20 years ago, there always are issues, as there are in all franchise systems. One example, says Messer, is whenever the franchisor considers making changes to the franchise agreement. Involving the IOLCF in advance as those changes are being considered, rather than as a done deal, goes a long way to smooth the transition. As for the future, says Messer, "We are looking to prosper and grow a successful franchise business. Let's work together to make this as conducive to growth and prosperity as possible."

Power in numbers

Misty Chally is executive director of the Coalition of Franchisee Associations, whose 18 member associations represent more than 38,000 franchise owners with more than 87,000 locations employing more than 1.4 million people.

"We're facing constant battles with the U.S. government and Congress," says Chally, with regulations on such critical items as joint employer, overtime regulations, ambush election rules, and the Affordable Care Act.

"We're on the defense a lot in the states," she says, "particularly regarding minimum wage increases--and not only in states, but in localities, which is tough to monitor and is how a lot of federal legislation gets started. Minimum wage will continue to be a key issue in 2016."

At the municipal level, New York City and Seattle have passed legislation forcing franchisees to comply with minimum wage hikes sooner than non-franchised businesses, based on what many consider the spurious reasoning that, because they display the trademarks of their franchisor, the franchisees themselves are big businesses.

"I think it's a complete lack of understanding about franchising," says Chally. What's needed to remedy this misunderstanding, she says is a massive, ongoing educational effort at every level--as well as forging alliances to build strength in numbers. "We work very closely with the Chamber of Commerce, NFIB, NRA, and IFA to get information to our franchisees," she says, who then can take action at the local and state levels, as well as in Washington, D.C.

"One of our top issues is to promote a more fair landscape in relation to rights granted in the franchise agreement," says Chally. The CFA is supporting two Congressional bills intended to help candidates who are considering buying a franchise: H.R. 3196 (Fair Franchise Act of 2015) and H.R. 3559 (Small Business Administration Franchise Loan Transparency Act of 2015). Both were introduced by Rep. Keith Ellison (D-MN).

At the state level, Chally says she is "very excited" about the passage of A.B. 525 in California, which passed in October and applies to all franchise agreements signed on or after January 1, 2016. Chally, who was a state lobbyist before coming to the CFA, knows how difficult it can be to pass a bill, even the most benign. Along with CFA Chair Keith Miller and CFA Vice Chair Rob Branca, she worked with the IFA to come up with the language that would most likely pass the state legislature and maximize the goals of the CFA's members. "I don't think it should be easy to pass a bill," she says. "Legislators need to take a look at all sides and understand the full impact of a bill before casting their vote."

Miller, a multi-unit Subway franchisee in California, issued the following statement after the bill became law in October:

"This journey started almost five years ago, when then Assemblyman Jared Huffman introduced a comprehensive franchise bill. While not everything wished for was achieved, the legislation signed today is a significant achievement. It will give franchisees more rights against termination. It will add transparency to the transfer process. It will put meaningful remedies for improper terminations or non-renewals. And most importantly, it acknowledges that franchisees own the equipment and fixtures they purchased for their business, and that franchisors must purchase them to take possession upon termination or expiration of the franchise agreement."

Franchisors, on the other hand, are not universally pleased with the new law. Yet as California goes, so goes the nation?

A good way for franchisees to educate themselves on the issues and test the waters of political involvement is to attend the CFA Day Forum this March 17 and 18 in Washington, D.C. This year the agenda has changed so that all events and receptions will take place on Capitol Hill. With the raft of legislation franchisees must sort out this year, the legal session has been extended with an opportunity to meet with attorneys at a roundtable breakfast--and of course, visit the Hill and meet with their elected representatives to make their concerns known.

"We need more voices in this fight," says Chally, adding that the CFA offers individual memberships to franchisees whose brands have no franchisee association.

Into the fray

One franchisee who's embraced an activist role in the fight for franchisee rights is Mara Fortin, who in 2007 became the first franchisee of Nothing Bundt Cakes. Today she has seven bakeries and chairs the brand's franchise advisory committee.

Fortin has become involved at the local, state, and national levels as an advocate for franchisees. She is one of several co-chairs in the Coalition to Save Local Businesses, which is supported by both the CFA and the IFA, along with more than two dozen other business organizations including the NFIB, the Asian American Hotel Owners Association, and the U.S. Chamber of Commerce. She's also testified before Congress to support pro-franchisee legislation (see sidebar), penned an op-ed for The San Diego Union-Tribune, and has appeared on CNBC and Fox Business News.

"There was absolutely no reason for the NLRB to change the standard in the Browning-Ferris case. Nothing good can come out of this," says Fortin, who was a practicing attorney before becoming a franchisee. "It was case by case before. Why change a rule for the 5 percent abusing it and punish the 95 percent who follow the rules?"

Fortin urges franchisees to be more vocal and to participate in public events and meet with legislators. "Franchisees need to get involved. We have to send a message to all our elected officials and educate them about what a franchise is," she says. ""There is no upside to joint employer. How many small businesses need to close their doors before they realize there's a problem?"

A first step for franchisees, she says, is to educate themselves on the issues. She suggests starting by reaching out to their franchisee association, the CFA, the IFA, local councils, political action committees, and any other organizations involved in supporting franchisee rights.

A second step is to shore up their own operations to be sure they're on solid ground contractually with their franchisor before speaking out. "Everyone's afraid if they say something and stand up the brand will retaliate and they won't grow," says Fortin. "What I say is make sure you are following all the brand requirements. Don't go rogue. Don't sell non-brand items. Be vocal, be fearless. Because over time your voice will be heard. And your brand will realize you're in the trenches for the long haul to improve the brand."

While an attempt to pass H.R. 3459 (Protecting Local Business Opportunity Act) passed in the House in the previous Congress, the measure failed to be included in the year-end federal spending bill. However, in California, where her stores are located, A.B. 525 did pass, and she organized an event for franchisees to celebrate in Sacramento in January, along with visits to legislators. As the brand's first franchisee approaches her 10-year renewal, it will be under the new law.

Balancing franchise agreements

One of the more interesting discussions in franchising today is the question of balance in franchise agreements. Beyond the traditional sticking points--pre-sale disclosure, FPRs, encroachment, renewals, transfers, right of first refusal, remodeling, tech upgrades, early termination, cure periods, personal guarantees, liquid damages--there's a fundamental tension between the franchisor's role as protector of the brand versus the financial investment/risk of the franchisee.

If franchisees don't invest anything, franchising cannot work, says Miller. Yet, he says, the financial protections in franchising are "completely backwards" from the rest of the business world, where the investor is protected against the institution. "If you invest $100,000 in a security, what's your risk? $100,000. If you invest in a franchise, what's at risk? Everything," he says. "The franchisee is the one who should be protected."

"Most people think the largest investment they'll ever make is when they buy a house or a stock. The SEC provides more protection and banking laws for house buyers than for a person who invests in a franchise," says Ed Wolak, who signed his first franchise agreement in 1975 with Dunkin' Donuts. Today his company, The Wolak Group, operates more than 70 Dunkin' Donuts in Maine, New Hampshire, and New York, as well a central production facility with the capacity to supply up to 120 stores.

Wolak has seen his share of franchise agreements, as well as owners of the brand, from founder Bill Rosenberg and his son Bob to various private equity firms. "Along the way, the franchise agreement became draconian to keep the flock in control, which I totally support and understand," he says. Franchisees need to know the franchise owner across town is running a good operation and meeting brand standards; if not, it reflects badly on him and all the other Dunkin' franchisees. Still, during the past 40 years, he says, "The franchise agreement has gone from maybe 4 pages to over 30 pages." Then there are additional documents, most notably the FDD: Dunkin's 2015 FDD weighed in at 660 pages.

Until last year, Aziz Hashim, the incoming 2016 chair of the IFA, dealt with onerous clauses in franchise agreements during his two decades as a franchisee of multiple restaurant brands. Today, as the founder and managing partner of NRD Capital, a franchisee-funded and managed equity fund that invests in franchise brands, he's on the franchisor side--and determined to rewrite the franchise agreements of any franchise the fund buys to reflect his fundamental rule about investing in a brand: "Is this an agreement I would sign as a franchisee?"

In May, NRD Capital announced its first acquisition: Frisch's Restaurants, operator of 95 Big Boy restaurants in Ohio, Kentucky and Indiana, plus 24 other locations it franchised, for approximately $175 million. Hashim is writing a brand new franchise agreement--not necessarily because it was bad for the franchisees, but because it was 20 years old.

His intention is not to balance the agreement so it's equal, but rather to "address the imbalance" that has come to dominate franchise agreements to favor the franchisors, seemingly more with each passing year. "A franchise agreement cannot be equal because you're licensing someone else's property," he says, much as signing a lease with a landlord.

Yes, franchise agreements are restrictive, meant to protect the entire system by setting standards and providing a mechanism to terminate bad actors who hurt the system.

"You have to protect your brand," Hashim says. Yet, at the same time, franchisees invest hundreds of thousands of dollars, sometimes millions, to build and expand their portfolio and the brand, so their investment must be protected too, he says. "In our agreement we're going to have some of those protections for the franchisee."

Two areas he's looking at are personal guarantees and transfer terms. "Personal guarantees for people who are signing franchise agreements whose corporations are very well capitalized are ridiculous. Why should I sign a franchise agreement if my corporation has substantial assets, much more than required by the franchisor in the qualification process?"

When it comes to transfers, he says, most franchise agreements have a provision that the buyer must sign the then-current franchise agreement. Yet, if the seller made their initial investment decision based on a royalty rate calculated over a 20-year agreement, this provision reduces the value of their investment if they sell in say, year 13 and the buyer has to sign at a higher rate.

"One thing that should not change is the royalty rate. That needs to be guaranteed for 20 years--even if you sell the business," says Hashim. "To raise it from 4 to 5 percent decreases my equity. When the term is over, all bets are off."

On the other hand, many people think franchise agreements should be more equal.

"I disagree pretty strongly with the idea that franchise agreements should not be balanced," says attorney Ron Gardner, managing partner at Dady & Gardner, where he represents franchisee associations. He says that before franchising took hold, companies raised capital by selling parts of themselves in the form of shares. The government's role was to protect the usually smaller investor from being taken advantage of by the usually larger entity they were investing in, as well as by the banks.

"Somewhere along the line, as franchising grew, those roles got reversed," he says, and it became about protecting the brand, not the investor and their money. "Why in franchising do we protect the brand, not the money?" he asks.

Fortin, the multi-unit franchisee and attorney, has an opinion somewhere in between, based on the longevity of the franchisee in the system. Before the franchise agreement is signed, she says, the balance should not be equal. "The franchisor is definitely sitting in the position of advising, teaching, and giving the franchisee something of value." At that point, she says, "It's fair that the franchisor has more power."

However, once the franchisee has become more sophisticated and has contributed years of royalties to the system, it's time to rethink the balance in the franchisee-franchisor relationship. At that point, the relationship should be 50/50, she says--and reflected in the franchise agreement. A good, experienced franchisee can be a "gold mine" in helping the franchisor improve the system for the benefit of all. "I've been with Nothing Bundt Cake for 10 years, longer than most of the staff," she says. "It should be a win/win."

The joint employer initiative from the NLRB has brought up how unbalanced the franchisee-franchisor relationship is, says attorney Eric Karp, a partner at Witmer, Karp, Warner & Ryan, where he represents franchisee associations. The truth, he says, is that the only place the franchisee has some control is to hire and fire and set the wages etc., of the employees. It would be nice if the NLRB agreed.

Educating Congress

On September 29, 2015, Mara Fortin, a 7-unit franchisee of Nothing Bundt Cakes and a co-chair of Coalition to Save Local Businesses testified before the U.S. House of Representatives Committee on Education and the Workforce Subcommittee on Health, Employment, Labor, and Pensions at a legislative hearing on H.R. 3459 (Protecting Local Business Opportunity Act). What follows are excerpts from Fortin's testimony:

• "The simple, one-sentence legislation contained in H.R. 3459 is the solution that can protect small businesses like mine and give us certainty that out-of-touch regulators are not going to threaten our business again in the future."
• "Under the NLRB's ruling in Browning-Ferris Industries, my franchisor could be found to be the joint employer of my employees."
• "The real world consequence of the NLRB's decision is that it will lead to consolidation among our franchisors and a loss of autonomy for local franchise business owners.... My franchisor may decide to exert more control over my business, relegating me to a middle manager role for which I did not sign up."
• "To consider my franchisor a joint employer of my employees is to completely misunderstand how franchising works. When I entered into a franchise agreement with Nothing Bundt Cakes, I signed up to independently operate my business, and that is what I have done for more than eight years. My franchisor provides the recognized brands and trademarks, a set of business practices to ensure consistency and quality across all franchised locations, and support for marketing and advertising. Everything else is up to me--I hire my workers and set their wage and benefit rates. I manage my inventory and purchase equipment. I pay taxes as my own small business, with my own identification number. And I help my employees when they are in need of assistance. My franchisor plays no part in any of these key functions that only a true and sole employer performs. The suggestion that my franchisor is in any way an 'employer' of my workers is insulting, and takes away from all the effort I have put in over the years to build a successful small business."
• "...Nothing exasperates me more than this manufactured joint employer threat by unelected regulators who have never faced the stress of a small business owner."

Improving the System

Gary Robins is a longtime Supercuts franchisee with 48 salons. He's involved in the independent Supercuts Franchisee Association (SFA), as well as with the CFA, where he's a board member. "The CFA helps us make our voice at SFA be a little louder and have a little bit more clarity," he says. "We want to run our association better and bring more value to our members by getting together with other association members."

The SFA's mission is to enhance the personal and professional lives of its members by sharing best practices, he says. It's also to present a "united voice from the franchisees to take to our franchisor--mostly in a positive direction." He also appreciates the value of being in a group of successful people in the same business dealing with the same issues he is.

"Whatever challenge you may be experiencing, other people have gone ahead of you and have addressed that challenge in nine different ways from five different directions," he says. "Why wouldn't you join the association? It's a no-brainer."

On the legislative front, he says, "There are a lot of great franchisors out there, but there are some bad actors." The challenge is how to advance legislation to protect against the bad actors without causing harm to the people who are doing it right. "It's a balancing act."

"We CFA work cooperatively with other organizations, the IFA specifically where we have common ground, and make reasonable progress on franchisee-franchisor issues, which would include supporting certain aspects of legislation, whether at the state or federal level to protect franchisee equity."

Internally, says Robins, relations with the franchisor are good these days--but there's always room for improvement. "How do we make the brand better?" he asks. "There's always a little bit of friction. It's their brand, they own it. We have a different opinion sometimes on how to improve the brand. That's always the issue: working in a spirit of cooperative endeavor. I think our franchisor is great in that respect. They certainly work with us in a spirit of cooperation."

One item on his agenda this year is the large number of new franchisees entering the Supercuts system. "We have more new franchisees in the past 2 years than in past 15 years combined," he says. This is a new issue for the brand he says, and raises two questions: 1) how to get the new franchisees engaged in the SFA, and 2) how to ensure corporate is ramping up its resources to make sure the new franchisees are successful.

Robins says his involvement stems from his passion about entrepreneurship and franchising. "I think franchising is a great place to start, and I want to protect it. I want to see more young people start businesses."

At end of day, says Robins, there are two types of franchisors: 1) those who say, "This is our brand, we own it," and 2) those who say, "Our success flows from the success of our franchisees." Fortunately, he counts Supercuts among the latter.