Maintaining Franchise Agreements For Hotels
A Franchise is the right to use the brand and the business model of a specific parent company for a prescribed period of time. It is a method for expanding a business and distributing products and services through a licensing relationship.
A Franchisor is a company that ‘gives’ the license to a third party for the conducting of a business under their trademark. They specify the products and services that should be offered.
A Franchisee is a company who ‘uses’ the license of the franchisor to do business under his trade name, according to terms and conditions of the contract.
In other words it means that the parent Hotel Franchise Company provides permission for the local owner to use the parent company’s name (brand) and products. A franchise can be owned as a corporation, sole proprietorship, limited liability company or other business structure. In hospitality industry, a Hotel Franchise can be vaguely compared to a chain, since it is a management agreement that provides certain services (brand, reservation system, support, etc.) in return to follow specific regulations and procedures. In other words the hotel brand is shared by other proprietors. Beneficial is that the Franchisees can brand their hotel with a well-known and popular brand, while the franchise contract provides them with a powerful set of tools to drive new business. Franchisees operate business for themselves but not by themselves. The advantages of a Hotel Franchise (for the Franchisees) are:
• strong brand portfolio
• specific set of tools
• strong approach to standards
• good reputation
• training programs
• consultation and advice service
• marketing programs
The benefits for the franchisor, on the other hand, is an alternative to building “”chain stores/ hotels”” to distribute their products. It avoids the investments and liability of a chain. The franchisor’s success however depends on the success of the franchisees. Not only hotels but also many chain restaurants (i.e. McDonalds) and retail stores (i.e. 7-Eleven) are owned as franchises.
How to Buy a Hotel Franchise
Business owners interested in franchising hotels have several options, including starting a new franchise or branding a current hotel as part of a regional, national or international franchise. Buying a hotel franchise means following a series of basic steps, regardless of the corporation offering the franchise.
• Review your personal records to determine your financial worth and the amount of available cash you have to invest in a hotel franchise.
• Meet with a lender to prequalify for a business franchise loan. You’ll need to bring your financial records, including federal tax documents, bank statements and proof of income, to discuss the type of loans available. Explain that you are interested in buying a hotel franchise and what type of hotel you are interested in.
• Make a list of your skills, training and experience. Note how these relate to ownership, management and operations of a hotel franchise.
• Brainstorm the type of hotel that interests you and matches your skills and experience. There are numerous hotel types, from high-end luxury to moderately priced to budget. They come in many sizes as well. Some feature hundreds of guests rooms, full-service dining and lounge facilities and thousands of square feet of meeting rooms. Others might have only a couple of dozen guest rooms and a snack machine in the check-in area. Some hotels cater to tourists, while others cater to business travelers. Decide what works best for you. After that, decide where you might want to locate your hotel franchise. For example, if you are interested in a hotel that caters to business travelers, you might want to look at a location near an office park or commercial district.
• Conduct research, on the Web and through hotel trade journals, on hotel franchise opportunities. Note the ones that best match your skills, experience and interests. Alternatively, you can contact a commercial real estate agent or broker to review franchised hotels already on the market.
• Shop for hotel franchise offerings. If you currently own a hotel and want to affiliate your business with a hotel brand, shop branding-only franchise opportunities using the Internet.
• Evaluate the hotel franchise offerings. Contact the hotel’s corporate management about specific franchises for sale, or franchise-branding opportunities. Find the appropriate contact representative on the hotels’ franchise websites to obtain an email address, fax, telephone number and street address to request franchise portfolios.
• Request franchise company questionnaires for your franchise selections. These questionnaires typically ask you to submit contact information, your proposed hotel location, and details about your ideal hotel operation. You must also provide a narrative of your goals, details of your development and management experience, and your professional memberships and awards. If you want to convert a current hotel to a brand-name franchise, you must provide specific information about your hotel’s operation and location.
• Obtain franchise disclosures from the hotel corporations that interest you. Federal law requires that the new franchisee have a 14-day disclosure examination period before signing a franchise purchase agreement or depositing any money with the corporation. Some states also require separate franchise disclosure documents for franchise opportunities within state boundaries. Franchised hotels currently on the market must also complete any state-mandated real estate disclosure.
• Hire a marketing professional with experience in hotel franchising to review the information included as part of the disclosure information. The document lists current franchises and any corporate franchise failures. Ask the professional to also examine the marketing information for accuracy or contract for a new market analysis to ensure the local region has potential for a successful hotel operation.
• Meet with the hotel’s corporate representative to draw up a franchise agreement. The agreement should meet your requirements for hotel type and geographic location. Draw up a mutually acceptable agreement for franchise branding, if you currently own a hotel.
• Review the franchise agreement and disclosure, or branding agreement, with a legal professional with expertise in hotel franchising operations.
• Complete your franchise loan application with the loan broker or bank agent. Submit the franchise agreement and disclosure to the bank for loan approval.
Hotel Franchise Agreements: The biggest mistakes a hotel owner can make
Hotels need brands, and brands need hotels. For many years, hotel brands have been growing in importance for the success of hotels in the United States and abroad. The trend toward branding is quite a phenomenon. According to numbers we have seen, In the early 1990s, approximately 40% of the hotels in the U.S. were branded and the balance were independent. Now the number is probably closer to 80% or more of the hotels are branded or brand-affiliated. The branding is often accomplished by a franchise or license agreement from a company owning the brand. Other times it is accomplished by a branded hotel management company entering into a management agreement with the owner of the hotel, providing both the brand and management for the property. Although we have spent a lot of time on Hotel Law Blog discussing hotel management agreements, today we are going to focus on the franchise or license agreement arrangements. With more than 20 years’ experience working with more than 1,000 hotel management and franchise agreements, we have some perspectives that may be worth considering.
Focusing on just one brand and letting them know you “have” to have them.
Even if the brand is perfect, the best way to get a great brand and a fair deal is to make sure there is competition, compare the results, and make sure each brand knows there is at least one other brand to “meet or beat.” The process isn’t an auction, but it is a controlled, selective competition that brings out the best deals from the brands and gives the owner the best choice.
Trying to do it yourself – it’s a false economy. You don’t know what you don’t know.
Finding a good brand is intentional, not accidental, and drawing out the best business and legal terms in a franchise takes someone who has been there before. Hotel executives make their living by negotiating hundreds of deals with amateurs. Unless you identify the real issues and realistically approach your project and its needs, your deal will get shopworn and tired before it is positioned. And if you let the franchisor drive the process, you are likely to find yourself with a letter of intent or term sheet before you have identified your needs and shaped the conversation.
Starting the process by getting proposals from the brand to save time and money.
For all intents and purposes, the letter of intent is the final agreement – unless you identify the points of negotiation, virtually every franchisor will demand that you sign their franchise agreement as-is. Franchise agreements are not like other commercially-negotiated agreements; franchisors demand uniformity and making changes, even changes which make business sense, must be identified early. It is true that letters are generally non-binding, but the only alternative to agreeing to the franchisor’s terms is often to walk away from the agreement, typically forfeiting a substantial (often six figure) application fee!
Believing that the franchisor’s interests are aligned with yours because they make an investment in the property.
It is gratifying when a franchisor offers to help fund your project. However, their needs are never fully aligned with yours. Franchisors almost never have money at risk; instead, they provide “key money – forgivable loans – or credit enhancements which amortize over the life of the franchise. Franchisors can get their money back if you try to terminate the franchise, or default, or for a variety of other reasons, and their “investment” is often backed by a personal guarantee. Moreover, the relatively small amount of key money comes at a high price, typically a longer duration, more onerous terms, and less flexibility. Finally, an owner must always understand that the interests of brands always diverge from the interests of owners. Owners are concerned about the health, well-being and profitability of their individual property, while the brand is concerned about the value of the brand, regardless of the performance and value of the individual hotels in the chain.
Relying on a third party manager to protect your interests.
Third party managers can help, but they are as interested in pleasing the brand as they are in pleasing the owner – in fact, franchisors typically require that the manager acknowledge that the franchise agreement overrides the management agreement! The principals and operators in management companies often are drawn from the ranks of the brands, and they get a substantial part of their business from the brands, and their loyalty can be diluted. The manager can help, and in particular can help comply with the franchise, but if there is a problem, the owner stands alone.
Brands and owners need each other. While tension always exists in the relationship, if they share the same vision, they have a better chance of a successful relationship. On the other hand, when an owner enters into a franchise agreement without understanding its ramifications and without creating a level playing field, the likelihood of success is limited at best.
To reach an agreement that is successful for both the brand and the owner, there must be parity in the process. Owners need the same level of legal representation that the franchisor will have. The franchisor’s lawyers will have negotiated hundreds of these agreements. Your lawyer should have this level of practical experience, as well. The franchisor’s lawyers will understand the implications and ramifications of each sentence and phrase in the agreement. So should your lawyer. The franchisor’s lawyers will make sure the franchisor takes as little risk as possible – that’s the lawyers’ job. Your lawyer should do the same job for you.
Things To Negotiate In Your Next Franchise Agreement
• Franchise and Royalty Fees: While it’s unlikely that franchise fees will be reduced for the entire term of the agreement, a “ramp up” in fees over the initial years of the agreement, particularly for a newly built hotel, can often be achieved. While other chain fees are more difficult to negotiate, it can be possible to get some temporary relief there as well.
• Area of Protection or Non-Competition: Hotel owners are properly concerned about the brand opening a competing hotel within their property’s market area. If it’s not offered, a franchisee should ask during the negotiations for a geographic area of protection or non-competition. The length and breadth of the restriction varies, but some protection is usually granted.
• Ownership Transfer: Most franchise agreements are still based on a simple ownership model, contemplating a single owner (or investment group) of a single hotel. Our experience is that more complicated owners (including REITs, private equity groups, real estate funds and other institutional investors) are increasingly focused on hotel investments. As a result, the transfer provisions should consider the structure of the owner and flexibility for transfers to certain related parties. In that regard, while a sale of a hotel often precipitates a property improvement plan or PIP, the owners should not trigger a new franchise agreement negotiation, set of franchise application fees and PIP when the transfer is to a related corporate entity or to another family member or trust set up for estate planning purposes.
• Independent Management and Changes in Management: The essence of franchise structure is providing the power of a brand with the greater flexibility and responsiveness of an independent operator (i.e. an operator unrelated to the brand). A good independent operator can provide an owner with a valuable buffer to the brand’s demands for operating and capital expenditures, implementation of new and expensive brand standards, property improvement plans, and certain brand programs that may not make sense for a given property. While brands are, understandably, concerned that an operator must have the experience to run the property, the management company should be the owner’s choice, and should have primary loyalty to the owner, not the brand. Thus, it’s important to prevent a franchisor from having veto power over change in management of the hotel.
• Liquidated Damages: Liquidated damage provisions in the franchise agreement give the franchisor the ability to collect damages on the early termination of the franchise agreement. They can be a key inhibitor to the owner’s ability to maximize the value of the property on sale, because liquidated damages have ballooned in recent years to as much as five times the average combined franchise fees and reimbursements paid to the franchisor. There are usually ways to both reduce the amount of the damages as well as restrict the potential transactions that might trigger payment.
• Capital Investments: Franchise agreements usually give the brands the ability to require substantial additional capital investments by owners to meet new physical brand requirements. There are a number of ways to reduce an owner’s exposure, including restricting time periods and clarifying the types of capital improvements that can be required. This is particularly the case for a newly built property or an acquired property that may have recently undergone renovation.
• Personal Guarantees: Most franchisors require guarantees. Owners should seek to eliminate, or at least restrict the scope, of guarantees. As more and more owners are institutional, this requirement is less and less meaningful.
• Key Money: For the last several years, many brands have been willing to provide key money as a means of securing franchise agreements. While owners are typically excited about the prospect of getting additional funds, they should remember two things: First, key money is typically only paid after the hotel opens; it doesn’t provide funds for construction. Second, and more importantly, key money is probably the most expensive money an owner will get; in return for key money, brands typically will be even less willing to negotiate important franchise agreement provisions. While there are limited areas that an owner can expect to successfully negotiate with a brand in a franchise agreement, changes in these limited areas can make a big difference in the value of the brand to the owner. Our expertise in understanding how to implement these changes, and what other changes might be appropriate in a particular circumstance, has achieved significant value for our clients.
Advantages of buying a franchise
• Franchises offer the independence of small business ownership supported by the benefits of a big business network.
• You don’t necessarily need business experience to run a franchise. Franchisors usually provide the training you need to operate their business model.
• Franchises have a higher rate of success than start-up businesses.
• You may find it easier to secure finance for a franchise. It may cost less to buy a franchise than start your own business of the same type.
• Franchises often have an established reputation and image, proven management and work practices, access to national advertising and ongoing support.
Disadvantages of buying a franchise
• Buying a franchise means entering into a formal agreement with your franchisor.
• Franchise agreements dictate how you run the business, so there may be little room for creativity.
• There are usually restrictions on where you operate, the products you sell and the suppliers you use.
• Bad performances by other franchisees may affect your franchise’s reputation.
• Buying a franchise means ongoing sharing of profit with the franchisor.
• Franchisors do not have to renew an agreement at the end of the franchise term.
Hotel Franchise Lawyer
When you need legal help with your hotel franchise in Utah, please call Ascent Law LLC for your free consultation (801) 676-5506. We want to help you.
8833 S. Redwood Road, Suite C
West Jordan, Utah
84088 United States
Telephone: (801) 676-5506