With their recognized names, training programs and proven business concepts, franchises can be very appealing investments for entrepreneurs. Before you commit to a franchise concept, however, understand that some franchisors may not provide a complete turn-key operation for their new franchisees. Where some, even good-intentioned, franchisors fall short is with commercial real estate matters – specifically in the areas of site selection and commercial lease negotiating – these are frequently left to the unsuspecting franchisee to handle. As The Lease Coach since 1993 and now co-authors of our new book, Negotiating Commercial Leases & Renewals For Dummies (Wiley, 2013), we have explained this to many prospective franchisees and helped them choose the best business location and negotiate their commercial lease for their maximum benefit.
When you are considering various franchise concepts and before obligating to any long-term lease commitment, consider the following advice (excerpted from our book).
The majority of commercial lease deals are five-year lease terms. However, exceptions to a five-year lease term have become more and more commonplace. The Lease Coach frequently negotiates three-year, seven-year or ten-year terms. A lease term can be stated in either years or months. It’s important to factor in the start date and the expiration date of the lease term relative to what’s best for your business. Franchise tenants should make sure their lease term matches their franchise term to avoid issues later with the lease running out too soon. This happens when the start date of the franchise agreement is prior to the start date of the lease agreement – which may be several months later, when the franchise business actually opens. The more money you invest in building out your space and setting up shop, the longer lease term you want.
Prospective franchisees are banking on a proven brand for their success, but finding the perfect location for a franchise concept can still be quite challenging. One franchisee told us there was such fierce competition for sites suitable for their industry that as the tenant, they didn’t negotiate the rental rate and simply agreed to whatever deal the landlord wanted. This was an isolated incident as in many market places the franchise tenant can still get a great lease deal if they know what they are doing.
If the franchise concept you’re buying into has a site criteria list, ask for it, and make sure you use it or include it in the leasing process. For example, a franchisor may stipulate that a good location is dictated by certain factors, such as age, population density, or income levels. A high-end frozen yogurt concept may do better in a more affluent or touristy area, for example.
The depth and experience of the franchisor, along with the brand and name of the franchise concept, may open leasing opportunity doors for you that would be difficult to crack as an independent tenant. The fact is, for new developments, most landlords strive for up to 100 percent national and regional chains and franchise tenants. Obviously, the brand-name recognition of a franchise can influence a landlord’s interest in you.
A soon-to-be multi-unit franchise told us that his franchisor had promised him extensive real estate support throughout the site selection and leasing process. When he and his wife went to the franchisor headquarters for the training program, they were surrounded by other wide-eyed new franchisees anxiously waiting to be trained so they could start opening new locations. On the fourth day of training, the franchisee went out for a walk to escape the classroom claustrophobia. By the time he returned, the trainer had completed covered the real estate component of the course. Although there was plenty of reading material, there really wasn’t any hands-on effort to help the franchisee during the actual leasing process.
Some franchisors are active in the site selection and lease negotiation process, but some simply introduce the franchisee to a local broker who supposedly works for the tenant. The problem is that the broker or agent is usually collecting a commission from the landlord. From most landlords’ perspectives, any and all agents or brokers who are receiving a commission from the landlord are supposed to be serving the landlord’s best interest, not the tenant’s. This well-intended introduction by the franchisor may not turn out to be in the franchisee’s best interest.
As a further note, in the franchise industry, the franchisor or the franchisee could sign the “head lease” with the landlord. By doing so, either party becomes the “head tenant.” Whoever signs the head lease maintains more control but will, conversely, spend more time on management issues including paying rent directly to the landlord and complaining about leasing issues.
Much like driving a car, maintaining control is an important factor. Whoever is behind the wheel is in the best position to steer the vehicle to a desired destination in a safe manner. Carrying this analogy further, franchisees holding the head lease are better protected with their investment. Should a royalty payment or two be missed, the franchisor cannot threaten to take the space over. Often, the franchisor completely controls and dictates the site selection process; however, a franchisee signing the head lease has much more say in the location selection. Should a franchisee with a head lease wish to ever sell his/her franchised business; this is a far simpler process requiring a lease assignment.
As The Lease Coach, we know full-well how franchisors often carry more weight with landlords and can negotiate favorable amounts of landlord’s work, leasehold improvement allowance, free rent, no deposit and so on. Note that not all franchisors will pass these benefits on to the franchisee. With a franchisee signing the head lease, any such inducements made can be to the franchisee’s benefit. One scenario we remember as being specifically relevant.
In this case, The Lease Coach successfully negotiated eight months of free rent plus a substantial tenant allowance as part of the lease deal for a former franchisor client … obviously, this client was delighted! Following our association, however, the franchisor then offered the space to the franchisee with the sublease agreement providing only three months of free rent and no tenant allowance. The franchisor pocketed the incentives and savings while the franchisee remained none the wiser.
Overall, the main reason that franchisors would have for being on the head lease would be to position themselves to re-open or resell that location and franchise if the existing franchisee closes. We have seen franchisors make a tremendous windfall by repackaging a failed franchisee location and reselling the entire space – including equipment and leasehold improvements – to another franchisee that is not aware of a previous franchisee’s history in that location.
It is not uncommon for the franchisor to require the franchisee to include in the lease agreement an exhibit or list of terms giving the franchisor limited rights in the event that franchisee defaults on the lease agreement.
As we lecture at franchise shows across the country, we are meeting with franchisors and noticing that more of them are not committing to head leases. Some franchisors are trending toward less risk by insisting their franchisees sign the head lease.
With a franchisee signing the head lease, the franchisee can control the real estate. This article does not provide enough space to examine all of the pros and cons of head leases, subleases and franchisee direct leases but, at least, the topic is now on the table. If you need to discuss your situation or have any questions about commercial and retail leases, please don’t hesitate to contact us.
Jeff Grandfield and Dale Willerton – The Lease Coach are Commercial Lease Consultants who work exclusively for tenants. Jeff and Dale are professional speakers and co-authors of Negotiating Commercial Leases & Renewals For Dummies (Wiley, 2013).
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