I recently read an article with the premise that this upcoming year is going to be one of if not the strongest periods ever for franchising because of (and not in spite of) COVID-19. Is it then possible the next year might be the best year ever for franchisees? That kind of speculation is reckless. However, it is fair to say that franchises are relatively strong restaurant investments during the COVID-19 pandemic.
Decline and Rebound of Restaurants
There is no sugar-coating it—COVID-19 has absolutely ravaged the restaurant industry as a whole. The National Restaurant Association has said that the restaurant industry has lost $120 billion in sales in March, April and May collectively, and that amount is expected to double by the end of 2020. While the brunt of this loss has been absorbed by full-service restaurants, quick-serves have not been entirely spared.
While chain restaurant transactions were down 43 percent year-over-year in the week ending April 12, as of early June—at a time when a majority of restaurants had reopened in some capacity—sit-down chains had recovered to a 30 percent decline year-over-year. Quick-service chains had recovered to just a 13 percent decline year-over-year. Certain counter-service franchises have recently even reported positive year-over-year sales during the pandemic. After experiencing an initial hit on sales, A&W Restaurants announced sales were up by double digits, Papa Johns has noted a 24 percent increase in North American sales and Popeyes has boasted that sales are up by the “very high 20s” percent. While full-serves have not generally been as quick to bounce back, there is some positive news coming out for the sector as well with some franchises reporting sales are returning to normal—such as Outback Steakhouse, which notes its reopened locations have recently approached 90 percent of pre-pandemic business.
Benefits of Franchising
So what makes franchises better-suited than independent restaurants to survive and even be considered a relatively attractive investment in the midst of a pandemic? Franchises tend to have strong and well-tested infrastructure in place to help franchisees adapt as necessary to survive and succeed in challenging times. For example, a franchisor can rapidly develop and help institute technology like online ordering systems, push expansion of business channels to include takeout and delivery, and implement touchless payment processes on an expedited basis. These adjustments have proven to be absolutely essential during the pandemic with the boom of sales utilizing these services while dine-in seating has been halted or reduced—and all while independent restaurants may struggle to shift their operating procedures and implement new technology in such a quick manner.
Domino’s is a great example of the franchise system benefiting its franchisees. Domino’s reported an increase in same-store, year-over-year sales of 20.9 percent between April 20 and May 17. Some of this increase can likely be attributed to the Domino’s-corporate shift to a 100 percent contactless model nationwide. This was a massive change in operating procedure that occurred over a period of weeks, something that the franchise concept allows to occur.
For all of the negative effects the pandemic has had on the restaurant industry, it has also created unique franchise investment opportunities. Some franchisors have slashed their royalty rates to help encourage continued franchise sales. Some existing franchisees may be unnerved by the effect the pandemic had on their operations and look for an exit, which, coupled with a decrease in sales, may open up the door for potential acquisitions at favorable pricing. Landlords may be in a difficult position due to defaults and difficulty collecting rent of their existing tenants, which may provide franchisees stronger negotiating power over their lease(s). Furthermore, the potential employment pool is deep with heavy layoffs and furloughs (particularly in the service industry), creating a strong base to draw from for new franchisees. Finally, there is inevitably going to be less competition from restaurants that have permanently shut down.
Steps for Investing
If you are interested in becoming a franchisee or expanding your franchise portfolio, your first step should be identifying concepts you think are the right fit for you and that you find to be handling the challenges presented by this pandemic well.
If you choose to develop new locations or purchase existing locations from the franchisor or existing franchisees, there are a slew of legal issues and documentation to work through with the franchisor, including review of the franchisor’s Franchise Disclosure Document (“FDD”) and Franchise Agreement, which is required to list all potential expenses, fees and restrictions imposed by the franchisor on the franchisee. Although franchisors do not like to deviate from their standard franchise agreements, it is certainly possible that franchisees now have more bargaining power than they had historically.
If you decide to purchase an existing portfolio from another franchisee, in addition to dealings with the franchisor, the process also involves the negotiation, documentation and closing of the purchase transaction with the existing franchisee. An experienced franchise attorney can greatly help with your review and digestion of the FDD and Franchise Agreement, as well as your negotiation with the franchisor and/or existing franchisee.
Although nobody can definitively tell you that the next year is going to be the best year ever for franchisees, the ability of franchises to quickly adapt to survive, recover and even thrive in challenging times, along with current unique investment benefits and incentives, presents an intriguing opportunity to explore becoming a franchisee or expand your existing franchise portfolio.
Brian R. Tunis is a member of the business transactions group at Trenam Law in Tampa. He represents buyers and sellers in the sale and financing of franchises and other businesses. He may be reached at firstname.lastname@example.org.