Master Franchising is by far the most common method to expand a foreign franchise network in Italy.Through Master Franchising, the franchisor grants a business partner based in Italy (Master Franchisee) the right to enter into exclusive sub-franchise agreements in a specific area with affiliates (sub- franchisee), granting them the right to use franchisor’s the brand and the franchise package. Therefore, the Master Franchisee basically represents the franchisor in the country involved, having direct relationships with the sub-franchisees and collecting fees directly from them. This feature distinguishes master franchising from all other legal forms of direct franchising. There are many advantages for a franchisor in resorting to Master Franchising for its international franchise expansion. In fact, Master-franchising requires less resources from the franchisor than direct franchising, involves less risk-taking and lower commitment level than other forms of international expansion, and reduces the complexity of managing the international network by reducing the number of the franchisor’s foreign partners in the Italian market.
1. What is Master franchising under a legal point of view?
Master Franchising is statistically the most frequently used method to expand a franchise network in Italy; according to the 2021 survey made by Assofranchising , 60% of foreign brands currently adopt this model in Italy.
Through Master Franchising, the franchisor grants a business partner based in Italy (Master Franchisee) the right to enter into exclusive sub-franchise agreements in a specific area with affiliates (sub- franchisee), granting them the right to use franchisor’s the brand and the franchise package.
Therefore Master Franchisee basically represents the franchisor in the country involved, having direct relationships with the sub-franchisees and collecting fees directly from them. This feature distinguishes master franchising from all other legal forms of direct franchising, such as area development and area representative, agreements, whereby the Franchisor keeps a legal direct relationship with the franchisees.
On the other hand, the franchisor has contractual relationships only with the Master franchisee, and not with the sub-franchisees. This means that, in the event of non-fulfillment of the sub-franchise agreements, the sub-franchisees will be able to claim only against the Master franchisee, who will in turn be liable towards the franchisor for breach of the Master franchise agreement.
2. Legal features of master franchising agreements
The number of sub-affiliates with which the Master Franchisee shall sign sub-franchise agreements and the timing within which these agreements must be signed is usually regulated by a Development schedule, attached to the Master Franchise Agreement.
The development schedule is of outmost importance in a master franchise agreement and it is usually carefully and intensely negotiated between the parties; often it is based on a business plan that should be prepared by the Master franchisee, given it has (or should have) a better knowledge of the Italian market.
Sometimes the Master Franchisee is required, especially in the initial phase, to open its own stores, in order to get to know the franchise concept better and convince the sub-franchisees to join the network.
Generally the franchisor provides the Master franchisee with initial training, products, technical and commercial assistance. The Master Franchisee has the obligation to promote the franchise concept, identify and select the sub-franchisees, take care of the regulatory aspects. Furthermore, the Master Franchisee is generally responsible for monitoring the sub-franchisees, for training, for assistance, for monitoring compliance with the brand.
Often the territorial exclusivity granted to the Master franchisee is limited, as the franchisor reserves the right to sell the products in the territory through other distribution channels that are not part of the network (for example outlets, supermarkets, corners, internet), or use new brands, or open your own direct stores. The initially identified exclusive territory can then be enlarged or reduced, depending on the results obtained by the Master Franchisee.
When the franchisor adopts the Master Franchise scheme, he generally provides the Master Franchisee with a draft standard sub-franchise contract to which he must comply, except for exceptions dictated by the peculiarities of the reference market and by local legislation. The conclusion of contracts with sub-franchisees is in any case generally subject to the approval of the franchisor.
An important issue in structuring a master franchise agreement in the Italian territory is to avoid that the termination of the Master Franchise relationship – for example due to default by the Master Franchisee – causes the sub-franchising relationships with foreign franchisees to cease, jeopardizing the entire network and exposing the franchisor to legal claims from part of the sub-franchisees.
To that extent, the master franchisor should be a party to each unit sub-franchise agreements – in addition to the master franchisee – to be able to take over the local network and enforce unit franchise agreements. Alternatively, the master agreement should contain a provision allowing the franchisor, at its option, to take an immediate assignment of all unit franchise agreements upon or before termination of the master franchise agreement.
Again, it is possible to provide in the master franchising agreement that, the master franchisor does not automatically take over from the Master Franchisee in relations with foreign sub-franchisees but reserves the right to do so, deciding from time to time with which sub-franchisee to maintain relations.
3. Advantages and disadvantages of Master franchising
There are many advantages for a franchisor in resorting to Master Franchising for its international franchise expansion. In fact, this model:
- allows a fast expansion of the network;
- reduces the investments typical of direct franchising form;
- allows the franchisor to adapt optimally to the peculiarities of the foreign market, thanks to the local knowledge, business skills, experience and contacts of the Master franchisee;
- allows the franchisor to share the risk with the Master franchisee, who is directly responsible to the sub-franchisees;
- reduces the complexity of managing the international network by reducing the number of the franchisor’s foreign partners in the market;
- reduces franchisor’s liabilities, since the master franchisee undertakes full responsibility for recruiting franchisees, and for training, servicing and supporting them.
On the other hand, master franchisees find it generally appealing to “manage” a franchise brand in their country, and to be the de facto franchisor there.
The disadvantages of Master franchising are essentially linked to the fact that the franchisor, not having direct relations with the sub-franchisees, loses to a large extent control over them, with the consequent possible negative effects on the brand and the image of the network.
Furthermore, Master Franchising ensures franchisors usually lower revenues than direct franchise, since they do not receive royalties from the sub-franchisees but only from the Master Franchisee.
4. Possible problems with Master franchising and how to avoid them
Of course, Master franchising is not a completely problem free expansion model.
Surveys conducted by several consultans show that the most significant problems that foreign franchisors face with their Italian master franchisees are the following:
- franchisors’ lack of understanding of Italian market;
- inadequate master franchisee’s training;
- inability of master franchisees to recruit sub-franchisees.
As a matter of fact, the first two problems can be easily avoided by careful franchisors.
A lack of understanding of the Italian market can be easily overcome by performing a serious preliminary feasibility analysis of the Italian market, and a careful legal due diligence. If a feasibility study and/or a legal due diligence have not been done, or if they not been done properly, than difficult problems may arise, not always easy to remedy.
Inadequate master franchisee’s training can be a major problems as well. Training and support are important to the success of master franchisees; most franchisors may not have documented properly each od the processes they follow in their day-to-day activities, at least in a way that can be easily usable by a master franchisee in Italy. Adequate training programs can be created, but this requires time and investment.
Coming to the third problem, probably the most critical factor incluencing Master franchise relations and success is the inability of master franchisees to recruit sub-franchisees. In fact, the main obligation of a Master franchisee is to promote the franchise concept in Italy, identify and select the sub-franchisees, and signing sub-franchising agreements with them.
The franchisor might develop targets by testing the market through an initial direct franchise arrangement. However, that rarely happens; therefore, the franchisor is left to study the market in other ways to determine the unit levels that can and should be attained by the Master frachisee.
This creates a high rate of failure, since many times targets in master franchise arrangements are not met. If the franchisee fails to comply with its development obligations, the whole expansion project in Italy might be at risk.
How to avoid this?
First, careful attention should be kept to set clear growth targets for the Italian master franchisee. This implies a careful analysis of the Italian market and competitors, that should be performed by a serious feasibility analysis.
But even the most appropriate analysis cannot avoid at all failures, especially if the Italian Master franchisee has not been selected properly and/or does not perform well its developing obligations.
In such case, the most severe consequence would be to terminate the Master franchise agreement in its entirety. As a less severe consequence, the franchisee’s development rights may be terminated. The franchisee would continue to service existing sub-franchisees and may be given the right to continue to develop on a right of first refusal basis.
Alternatively, its exclusivity may be terminated, which would allow the master franchisee to continue to develop in competition with the franchisor or another franchisee appointed by the franchisor. The franchisor would not, however, be able to grant exclusive development rights in the territory to the newly appointed franchisee.
The franchisee’s failure to comply with its development obligations could also result in the surrender of part of the territory for which exclusive rights were granted. This would allow the franchisor to develop the territory itself or to enter into a new franchise or other agreement with a different franchisee.
5. The selection of the “right” Italian Master franchisee
The selection of the Italian Master franchisee, which is indeed a crucial process.
While the master franchising structure is useful for spreading costs of administration, training and support, much depends on the quality of the master franchisee. A wrong choice can wreak havoc on a franchisor in the Italian market for years. Finding the “right” master franchisee can be time-consuming and expensive. The best master franchisees may also demand a better return on investment than ones of lesser quality.
A Master Franchisee should have the necessary experience, managerial skills and knowledge of the Italian market. Typically a company acting as a master franchisee (these are generally not sold to individuals) should be much more sophisticated and better capitalized than the average individual franchisee.
In the selection process of the Italian Master franchisees’ candidates, a crucial role is played by local advisors and brokers. Foreign franchisees will rarely have the necessary resources and knowledge to manage properly this delicate task. Although they might be tempted to accept the first Italian candidate that presents itself for this role, caution and patience is absolutely needed to find out and select the most appropriate candidate.
In any Master franchise agreement concerning the Italian territory (or part of it), a sort of trial is often provided, which is also useful to the the franchisor to test the franchise concept in Italy, verify the appropriate adaptations to the local reality and allow the Master franchisee to sign a minimum number of sub-franchise contracts.
This trial may consist of a limited exclusivity period of time (for example one year), with possible later renewal, and/or a limited territory (for example a region such as Lombardia or Lazio, or even a smaller territory such as the Milan or Rome area).
As far as master franchising is concerned, an initial cautious approach is recommended, as it allows franchisors to test their expansion project, thus creating the premises for further expansion.
While it is tempting to choose a single master franchisee for the entire Italian territory, because of the challenges outlined above, sometimes it is better to divide the Italian territory into smaller areas, such as the northern area – which is the richest and therefore often the most attractive for investors – or the central-south area, which is the most populous, thus having several master franchisees instead of one.
Granting the whole Italian territory to one master franchisee may result in strong development in only some parts of Italy, leaving other valuable opportunities unrealized.
6. Changes to foreign franchisor’s franchiseagreements, documents, manuals and training programs
Many foreign franchisors underestimate the changes in their franchise agreements, documents, manuals and training programs that are needed to adopt this model in Italy, and the related costs.
Master franchising is premised upon a sharing of the responsibilities for recruiting, training and supporting the sub-franchisees, and upon a sharing of the revenue stream from them. Whereas most franchisors embarking upon international franchising already have development agreements or are fairly conversant with how they work, most novice international franchisors are unfamiliar with the details of what is required to successfully use master franchising as a growth strategy in the Italian market.
First of all, foreign franchisors electing to use master franchising will need to prepare both the disclosure document and a master franchise agreement compliant to Italian franchise law, thus modifying their domestic franchise disclosure document and agreement to reflect the required changes. Additionally, they will have to adapt their standard , unit sub- franchise agreement that the master franchisee will have to sign with the Italian sub-franchisees.
This requires, of course, time and costs. Misunderstanding the time and cost required to properly draft the documents that are needed for a Master franchise transaction in Italy can be problematic. Franchisors are tipically in a hurry to have documents available once they have an international prospect, but they are also reluctant to incur the expenses of preparing documents until that point.
A foreign franchisor willing to elect a master franchising strategy for its expansion in Italy will have to prepare both a specific master franchise disclosure document and a specific sub-franchise disclosure document for the master franchisee’s adaptation to the Italian market and use to sell unit franchises.
The disclosure must be drafted in Italian language, according to the Italian franchise law.
The master franchise agreement and, above all, the standard sub-franchise agreement need not to be in Italian by Law: however, it is common practice in Italy that also such agreements are drafted in Italian language.
This adaptations should be done by an Italian law firm, with a significant knowledge and expertise in the franchising field. International franchisors will need to invest significant time in making the decisions required to prepare these documents, since they have different requirements from domestic unit franchise agreements.
Since the master franchisee usually fulfills most duties to franchisees that are specified in sub-franchise agreements that the franchisor would fulfill in a direct, domestic agreement, a thorough review and revision of the franchisor’s domestic franchise documents will be required to prepare the documents fit for Italy.
An important issue in structuring a master franchise agreement is the nature and content of the unit sub-franchise agreements to be granted by the master franchisee. When the franchisor uses the Master Franchise scheme, he generally provides the Master Franchisee with a draft standard sub-franchise contract to which he must comply, except for exceptions dictated by the peculiarity of the Italian market and by local legislation.
The franchisor will want to have continuity and the comfort that comes from requiring the use by the master franchisee of the form of unit agreement used in the franchisor’s home jurisdiction. On the other hand, the master franchisee will want to have some flexibility to adapt the standard agreement for Italian customs, circumstances, and law. The master franchisee may also wish to have some flexibility to vary the standard agreement for special deals and situations. Ultimately, there has to be a workable balance between the needs of the franchisor and the master franchisee.
In addition, just as all franchisors have developed operations manuals to explain to franchisees and their staffs the procedures for opening and operating a franchised business, franchisors that adopt master franchising as their expansion strategy in Italy should prepare master franchise manuals that explain how master franchisees are to fulfill their duties as master franchisees. This approach is used to create flexibility and confidentiality in operating procedures.
Although franchisors have typically operated multiple outlets before they begin franchising and can prepare their franchise operations manuals based upon how they have learned to successfully operate their businesses, many franchisors grant their first Italian master franchise agreement having no experience with international master franchising. Thus, they will need to either hire or retain someone locally with the appropriate experience to create the master franchise manual. This is a cost of master franchising that is often overlooked.
The unit franchisees’ operations manuals used by franchisors in their home markets typically require modifications to address different ways of doing business in Italy and to clarify the role of the franchisor and of the master franchisee in supporting the sub-franchisees.
These manuals usually must be translated into Italian, which can be a considerable additional expense. Although master franchise agreements often require master franchisees to adapt manuals to the Italian market and to bear responsibility for translating them, franchisors need at least to approve the adaptations and to check if the translation is true to the franchisor’s intentions.
Finally, training is a core element of every franchising program. Master Franchisees expect to be trained in how to operate the franchised business, or in how to adapt their pre-existing operating procedures to the franchise brand’s policies and procedures.
Most franchisors train the master franchisee in the skills needed to be a franchisor, using a formal classroom training at the franchisor’s headquarters, as well as on-the-job assistance in the master franchisee’s territory. This is an added expense for the franchisor, but it should result in the master franchisee successfully recruiting and establishing sub-franchisees.
When an Italian master franchise is granted, the initial training program and materials usually need to be modified to reflect how business is done in Italy. Much of training related to operating a franchised outlet will be assumed by the master franchisee; the franchisor will want to make sure that the essence of its program is retained by the master franchisee.
An entirely new training program must usually be established to teach a master franchisee how to act as a franchisor in the Italian territory. Franchisors should consider expenses related to creating training materials and manuals, the duration and location of the classroom component of the training, how many of the master franchisee’s team should attend the training, the nature of follow up training in the master franchisee’s territory, and ongoing training to help master franchisees improve their businesses.
Avv. Valerio Pandolfini
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The information contained in this article is of a general nature and is not to be considered an exhaustive examination of the various issues, nor is it intended to express an opinion or provide legal advice. Specific legal advice must be provided with regard to individual cases.