Planning for the ‘what if’s of business is critical for a business leader. When it comes to managing risk, the franchising relationship has its own complexities.
Many business owners are familiar with the concept (in theory) of the risk management matrix or plan where the potential risks to a business are identified and ranked in terms of likelihood of occurrence and risk minimisation strategies are planned and implemented.
For example, what if, your major supplier was to go under? What strategy is there to minimise risk to your business if this happens?
There are many different kinds of risk to a business the commercial risk related to the market viability of a product or service or environmental risk such as the potential fire risk to a manufacturing plant. Different strategies can be used to avoid or minimise risk and even shift some risks to another party.
Some concepts to think about in risk management are:
- IDENTIFY the potential risks or scenarios
- AVOID the risk if possible
- MINIMISE the risk if you can’t avoid it entirely
- TRANSFER some or all risk to a third party such as through contractual terms (including indemnities) or insurance
Emergency services approach disaster planning use the “PPRR” model of risk management – Prevention, Preparedness, Response and Recovery. This is particularly useful in thinking about how you approach a crisis – for example, a food business thinking about how to handle a food contamination scare.
While these are general principles which apply to all businesses, in the franchising world there are both added risks and reduced risks through the existence and nature of the franchise relationship.
Particular risks posed by franchising
Franchising adds some special risks for franchisors.
But firstly consider the risks that it minimises The most important one is probably that a franchisor can expand the brand name relatively quickly without the substantial capital investment which would otherwise be needed to be obtained from either a financier (e.g. bank) or other investors (e.g. through listing on the stock exchange or taking on partners).
Both of these methods have their own particular complications including the risk of the loss of control of the business which can be substantially limited through opting to franchise.
This doesn’t mean franchising doesn’t have its own risks – you may not have such a huge debt owed to the bank or have to sell part of your ‘baby’ to other people but now you have to deal with franchisees and comply with relevant legislation.
So there is compliance risk, a failure to comply with Franchising Code may lead to a financial penalty or financial loss in way of damages payable to a franchisee.
The obvious way to reduce and hopefully avoid that risk is to ensure your documents and procedures comply with the Code and keep yourself and staff updated on legal requirements.
While there are several risks associated with having franchisees involved in your business it is worth comparing this to the alternatives of employees or partners, which have their own risks.
The fact is, in addition to needing finance you simply cannot expand a business without some degree of delegation to others, whether they are employees, franchisees, contractors or business partners.
Employees, contractors and partners also need a contract, to set out the terms of the relationship and to ensure you can manage performance as required. And like franchisees, employees are also governed by legislation and so there is “compliance risk’ here too.
Unlike employees, franchisees cannot be as easily terminated or exited from the business if things don’t work out or they don’t perform.
In this sense a franchisee can be more akin to a business partner. You are likely to need to buy out a franchisee as you would a partner or investor if you want to sever the relationship, in the absence of any contractual rights under the franchise agreement.
A non-performing franchisee (like an employee) can also be a drain on resources absorbing management time as well as resulting in lost profits from the lower returns.
Limiting risks – avoid or minimise
While you cannot completely avoid the risk of a non performing franchisee you can minimise this risk with your recruitment and induction procedures. Additionally you need to have procedures to monitor and training to ensure that your franchisees maintain and hopefully improve performance.
A well drafted franchise agreement (just like an employment agreement) will therefore minimise the risks and like a partnership agreement will set out what happens at the end of the relationship (and how to end it).
Keeping a good document trail of communication with your franchisees will also reduce the risk of claims of the “he said she said” variety. It obviously helps enormously if you provide hard evidence of operational visits, offers of support, agreed KPIs etc.
Be aware also that the acts of franchisees, rightly or wrongly will reflect directly on the franchisor as well as all the other franchisees in your system.
So while it may seem a great bonus of franchising and risk management strategy that the employees are the legal responsibility of the franchisee as their employer, if the franchisee underpays its employees it will be the brand name of the system which will suffer the reputational damage.
In order to manage this risk to the franchisor, franchisees need to be provided with the information or the resources to ensure that they can comply with their legal duties as employers. Further the franchisor can take steps to require reporting to ensure compliance with these obligations as well as just monitoring sales and performance.
A formal franchise dispute management process that is consistent with the Code can be especially worthwhile in preventing potential issues that are identified from escalating into actual disputes and later into significant and costly litigation.
So the main tools of franchise risk management for a franchisor would be:
- A good recruitment and induction filter for franchisee selection
- Adequate and compliant franchise documentation
- Training (including ongoing) and support of franchisees
- Performance monitoring and reporting
- Good record keeping
- A formal franchise dispute management process
With respect to insurance, it is worth noting that while insurance against franchisee legal action was once prohibitive and not readily available in Australia, it has been provided to Australian franchisors to cover corporate and/or individual liability. It is worth asking your broker about what coverage is available and the cost of cover.
Adequate directors’ and officers’ insurance (D&O) is one policy that is worth ensuring is in place. It is not unheard of for individual directors or managers to be joined in litigation for claims by franchisees for wrongful termination or misleading and deceptive conduct.
Other coverage for other usual business risks including loss of key personnel and public liability are of course still needed.
Insurance is therefore the final method to limit liability for risk (by transferring it to the insurer) but one of course that you hope that is not needed.