Why franchises buy locations back from franchise owners

Why Franchises Buy Back Locations From Franchise Owners On Franchise Buyer

A major driver of growth for franchise systems is the growth of locations (units) once their concept has been validated. 

In its simplest form, franchise concept validation comes from the sustained demand for a product offered in a consistent form in multiple areas or locations.

However, regardless of the overall strength of a franchise model, during the term of the franchise agreement, circumstances may arise that create a need or desire for a franchise owner to exit the system early. This creates an opportunity, but seldom an obligation, for the franchisor to buy back the business.

Here are some of the reasons that franchisors may buy back locations:

Compassionate grounds

Personal circumstances can change dramatically and unexpectedly through the life of a franchise agreement. Quality franchise systems will work hard to support loyal franchisees that have fallen on hard times for circumstances outside of their control. 

Additional support, introducing prospective new franchisees or even buying back the unit to operate on a company owned basis, can all provide invaluable assistance to the impacted franchisee. 

Such actions can also have a very positive impact on the engagement of the broader and often close-knit franchise community in that network.

Brand Protection

Realistically, some franchisees or sites just do not work out. Whilst the obvious aim is to keep these instances to a minimum, problems do occur and the risks of underperforming sites and disgruntled franchisees in a network are significant. A poor customer experience, deteriorating brand standards or even business failure can all be very problematic for a franchise system. 

In some cases, franchise systems make a commercial decision that it is better to buy the business back to help the franchisee exit the system in a manner that maximises their equity and preserves their dignity.

While the details will often be confidential, other franchise owners in the network that are performing well, will generally welcome actions that help exit underperforming owners or problematic franchisees that may damage the brand; their brand.

In some cases, the franchisor will operate it to an orderly and dignified close. In other cases, they can restore the brand standards and rebuild the business to a point that it can be re-franchised or make an ongoing and valuable contribution as a company owned and operated store.

Bridging Purposes

Sometimes the franchisor will have a vested interest in maintaining the location over a longer period. They may have a long-term head lease obligation (the franchisors name is on the lease); it may have longer term appeal from an economic perspective; or it may represent an important piece in their broader community support objectives.

Lending Relationships On Franchise Buyer

Lending Relationships 

For many networks, many franchisees need to borrow funds to complete their purchase of the franchise. Accordingly, access to franchise finance is a key enabler of growth, and these lending relationships need to be developed and protected with finance providers.

In some cases, franchisors will buy back locations which will not only facilitate a smoother exit for the franchisee, but also to assist that owner to repay any funds owing to the lender. This can help eliminate or reduce any loss being faced by the lender, which in turn helps shore up their ongoing support for existing and new potential franchisees. 

Enterprise Value

Finally, and topical with a number of brands indicating an intention to taking their businesses public on the Australian Stock Exchange (ASX), is the buying back of units as a strategy to increase ‘enterprise’ (entire company) value.

Earnings are a key factor in the valuation of enterprise, and franchise systems are no different. Replacing small percentages of royalty revenue with profit contributions from strongly performing businesses within the franchise network can make good economic sense. This is often the case for those franchise systems courting private equity (PE) investment or with an eye on an initial public offering (IPO).

These buybacks can often also provide franchisees with clean and attractive exit terms.

In summary, there are varied and often good reasons why franchisors buy back locations, and these often result in a direct benefit to the franchisee involved.

A question to a franchisor you are considering buying into, asking whether they ever buy back locations and when they might consider doing so, may provide some useful insights into the attitudes of the franchise brand you are investigating.