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How Franchisees Fire Franchisor CEOs and Boards

Wall Street Investment Bankers and Private Equity Firms Often Look to be Blessed by Franchisees

Investment firms are bullish when franchisees are bullish on them /bmm

LEXINGTON, Ky.—Experts say that well organized franchisees can make profound changes in a franchisor’s behavior. Some have even been able to fire wayward CEOs, replace a franchisor’s board of directors, or spearhead a new strategy that lifts store profits and the brand.  

Yet, for some, paying dues to have an independent franchisee association in hopes of influencing a franchisor towards fairer franchising practices is not worth the trouble. After all, most independent franchisee associations are not even recognized by the franchisor. And the few that are do not seem to have much authority to do anything. So what are the benefits in participating?

Plenty, say experts.

Franchisee attorney Andrew Selden of Briggs and Morgan, P.A. emphasizes that if franchisees group together they can accomplish much. “Any group can influence decision-making by another, by creating a big enough fuss,” he says.

Franchisee attorney Robert Salkowski of Miami-based Zarco, Einhorn, Salkowski, & Brito P.A. agrees.

Salkowski observes that the efforts of an independent franchisee association can also change senior management in a private franchising firm. “Just look at the Dunkin' Donuts Independent Franchise Owners and Steve Horn.” Salkowski is referring to the resignation of the chief legal officer and board member after the association alleged that the hundreds of lawsuits that he and his department spearheaded made Dunkin’ Brands the most litigious system in franchising.  “I am convinced that DDIFO and its members, with the help of this [law] firm, was responsible in large part for him leaving, as a result of all of the negative publicity.”

Franchisees tend to think that they have their hands tied by their franchise agreement. Store owners are typically not Wall Street movers and shakers. When franchisees have disagreements that they cannot resolve, they go to court.

“Or, they ignore the problem,” states Michael Webster, chairman of the International Association of Franchisees and Dealers, a newly created federation of independent franchisee associations.

Legal expert Salkowski declares, “I believe that franchisees, especially well-organized franchisees, have the power to impact decisions of the board of the franchisor,” he states. “By expressing their views, franchisees are bound to make a difference, especially in large, publicly traded franchisors.”

But sometimes franchisees have to go beyond just creating a fuss or using attorneys to spearhead class action lawsuits. Skilled and well-organized franchisees can change a CEO, board and the direction of the franchising firm. Listed below are some companies that are examples of this — from the takeover of small private chains to hostile takeovers of publicly traded chains.

  • Denny’s Franchisee AssociationProblem: With 1,331 franchises and 220 company units, Denny’s CEO Nelson Marchiolli gambled that he could change the chain’s long-term trends of lower traffic. He also wanted to grow the chain faster by refranchising the hard-hit company restaurants. Unfortunately, his strategy has worsened not only the franchisor’s financial statements, but also store traffic and ticket prices.
    Solution: Two investment firms that had joined together for action wanted the franchisee association's blessing as they prepared for a proxy war to change the board and Denny’s CEO. Instead, Denny’s independent franchisee association last week decided it was better to stay with the devil you know and announced that the dissident shareholders had it wrong. The association said Marchiolli was actually listening to the chain’s franchise owners.

  • Wendy’s FranchiseesProblem: In October, 2007 franchisees wrote to the franchisor’s chairman James Pickett and other board directors complaining that the company’s leadership had taken them in the wrong direction by not listening to the insights of the chain’s operator-owners.
    Solution: Later, in April 2008, the new incoming CEO of Wendy’s from new owner Triarc Companies, Inc. publicly emphasized that it was critical for Wendy’s to learn from its franchise owners. "Wendy's franchisees are outperforming company stores… We need to be able to operate restaurants from both a customer service and a bottom line profit perspective."

  • Sona Medspa FranchiseesProblem: A small, privately held laser hair removal chain was plagued by franchisee complaints and a lawsuit that continued to hit the news. Franchise sales halted.
    Solution: Two franchisees with an investment bank background recruited a private equity firm to buy the franchisor.  The franchisee wheelers and dealers became the new chairman and CEO. The head office was moved from Franklin, Tennessee to the franchisees' home city of Charlotte, North Carolina.

  • Dunkin’ Donuts Independent Franchisee AssociationProblem: In 2005 Dunkin’ franchisees were concerned that franchisor Allied Domecq was going to sell the brand to a liquor competitor Pernod Ricard, who had minimal experience in running franchises and quick service restaurants.
    Solution: DDIFO quietly worked with the franchisor’s established advisory council to support then-CEO Jon Luther’s efforts to bring in private equity firms Bain Capital, T.H. Lee and the Carlyle Group to the rescue. Many among the members of DDIFO and its leadership would later reevaluate their support of Jon Luther’s efforts when it became known as the most litigious chain in the country towards its own franchisees.

Using Private Investment Firms

All of the examples above use investment banks and private investment firms for acquisition of the franchisor.

Private investment firms  often seek out the blessings of franchisees and their franchisee associations before a takeover. That’s an opportunity for well-organized franchisee associations to be in the driver’s seat.

The good news is that private equity firms, companies that raise private pools of capital for mergers and acquisitions, are once again pursuing restaurants after a two-year break. The most notable is Apollo Management pursuit of CKE Restaurants Inc (NYSE: CKR). Its buyout offer has been accepted. Another group is pursuing a hostile takeover to change Denny’s board (NYSE: DENN) and its strategic direction. There is also a rumor about Starbucks Corp and Morton’s Restaurant Group Inc. pursuing Jamba Inc. 

"In franchising companies, where there is a majority of restaurants that are franchised, then investment buyers clearly need the franchisees' support."

Randy Hiatt, president of Fessel International, a restaurant consulting firm that caters to some of the top brands in the country, such as Nestle, KFC and Sbarro, thinks that dealmakers have an affinity for franchised chains, if franchisees have the right structure and knowledge to engage private equity firms.

 “As can be seen by the recent news of the acquisition of CKE Restaurants, there is starting to be some private equity activity again in the restaurant business,” says Hiatt. “There is some money in the sidelines that could go to restaurants. But there are no traditional sources that are available.” He continues, “In franchising companies, where there is a majority of restaurants that are franchised, then investment buyers clearly need the franchisees’ support.”

Why do firms involved with mergers and acquisitions want the blessings of a chain’s franchise owner-operators when they acquire a franchising company?

John Gordon, principal of Pacific Management Consulting Group, a research and consulting firm for the restaurant industry, expounds, “Principals will be much more comfortable if the franchisees are onboard and won’t be kicking and fighting when the new owners take over.”

If a franchisor's stakeholders are looking to sell or go public, then there isn’t a problem.  Franchisees can organize to find a buyer. But franchisees can sometimes bump into an impassable bridge.

The problem is with founders and leaders of private franchising firms who are not motivated by money. Andy Jones is president and founder of PrivateEquityInfo.com, an online database that lists merger & acquisition players. He is also a former investment banker. “If I do not want you to take over my private company, there is no amount of money that can do it if I do not want to sell — if I’m a privately held company,” explains Jones.

Yet, sometimes founders of private chains may get tired when franchisees reach a point in which they want much more from the chain’s leadership. The founder may want to move on.

Some Franchisee Associations Are Well Positioned to Drive a Takeover

Hiatt thinks that the right franchisee associations can be in the driver’s seat in taking over the board and CEO of a public company — including hostile takeovers.

Restaurant consultant Gordon adds several caveats. “If there is a franchisee system that has only been able to string together one-, two- or three-unit franchise owners, it becomes more difficult for hostile takeovers. The associations in such systems typically do not have the knowledge and they cannot speak for the franchisees in a unified way.”

Gordon declares, “A defining metric of a strong enough franchisee community is if some members have multiunit stores of 30, 60, or 200 units, as there are in the ‘QSR majors’ as I call them.” He adds that the independent franchisee association for Quiznos would struggle because franchisees in that system tend to be single-unit owner-operators. 

"Where there is an established, large, well-ordered, well-steeped franchisee association structure... a takeover initiated by franchisees could happen."

“Where there is an established, large, well-ordered, well-steeped franchisee association structure, like there is in KFC [i.e. the Association of KFC Franchisees], a takeover initiated by franchisees could happen.” Gordon thinks it relates to having enough funds and sophistication. “If there isn’t a company-owned supply chain operation pulling gross profit dollars away from franchisees, and if the franchisee organization has the power to influence contracts and the like, that dramatically raises the association’s funding base and their threshold [for influence]. That is the case in KFC, where the franchisee association is dramatically active in a supply chain coop.”

Gordon thinks another sign of a more mature franchisee association is the willingness of big vendors to attend meetings because it shows a strong source of association funding and influence. “If you look at a franchisee association meeting, vendors [should be] lining up to display their goods,” he says. He thinks those are the kinds of associations that are best positioned to engage a takeover.

The founder of privateequityinfo.com advises franchisees to use an investment banker to match up with the right private equity firm. “Franchisees are smarter to use an investment banker,” he adds, “They know the tricks of the trade. While they do all these things, you can be running your business. People do not realize what a huge distraction it is to do a deal. It consumes a tremendous amount of time. It’s only to an association’s advantage to have an investment banker working for them.

Privateequityinfo.com, which offers a free trial, has a database of thousands of investment banks and private investment firms. One search resulted in a list of investment banks that were looking specifically for restaurant brands and franchises.

The IAFD chairman thinks that an independent franchisee association can be very valuable to an investment bank and private equity firm who are seeking legal control of the trademarks.  “First, the association who has a demonstrated ability to communicate top down and bottom up with the franchise operators is going to be a key player,” says the Toronto-based franchisee attorney. “Second, for most systems the franchisor does not have good financial records from all its operators.” This is even more the case during a hostile takeover in which the franchisor refuses to share information in the PE firm’s due diligence efforts. Besides looking at public records, Webster reminds buyers that “key financial data about the health of the franchise system remains in the hands of the owner-operators. The association can help with this problem also."

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