Strategies and Solutions for Franchises Facing Lease Challenges
A recent survey of business owners found 43% could not pay their rent on time or in full in April 2024, a statistic higher than anything reported in longitudinal tracking since a 49% rate was observed in March 2020 at the onset of the pandemic.
The independent restaurant sector was most heavily impacted, and more than half of all independent restaurant owners (52%) reported that they could not pay rent in full or on time. However, franchisors can implement the following strategies to provide better support and help franchisees avoid rent delinquency.
Negotiate Favorable Lease Agreements
Occupancy costs are the largest fixed long-term expense for most franchisees, and franchisors should pay close attention to the leases taken on by new units. The franchisor can contribute in multiple ways:
- Research Market Trends: Researching current market trends could greatly impact the lease negotiation process. Franchisors should have national databases and access to information they can share with potential tenants. Market trends provide a basic understanding of current rent rates in the area, vacancy rates, tenant improvement clauses, and other factors that could provide leverage when negotiating leases.
- Don’t Tackle It Solo: Franchisees should not tackle the lease negotiation process alone. The brand can provide access to third-party resources and experts who can help them navigate the business terms and negotiate the legal language and clauses. Consider working with both an attorney and a business broker for support throughout the negotiation process.
- Educate Franchisees: A franchisor has seen hundreds of leases, but for the new franchisee, this may be their first experience with a commercial lease. For this reason, it’s important for franchisors to be available to support the franchisee throughout the process. If you prefer to be hands-off, consider using a third party to conduct a webinar or learning series on key terms at a minimum.
- Negotiate Standard Protections: Be sure the franchisee knows to negotiate for terms that protect the business in case of tenant abandonment, high vacancy rates, massive CAMS increases, etc. This proactive approach will shelter the business from being impacted by economic shifts, such as those that have increased the small business rent delinquency rate.
- Negotiate Inclusion of a Franchisor Lease Rider: Franchisors should make sure they have a lease rider allowing them to step in and assign the lease to a new franchisee if needed. If the landlord does not accept a full lease rider, work to recommend standard assignment language that allows you and the tenant to assign the lease to a newly approved franchisee. If you can subvert the standard assignment process and install a new franchisee as a tenant, you can keep doors open that would otherwise shut when cash reserves are depleted.
- Review Lease Terms Regularly: The franchisor must maintain accurate records on all leases, escalation clauses, option terms, etc. The last thing you want is for the franchisee to fail to renew an option on time and be forced to renegotiate lease terms at the landlord’s new rate. This is a basic function and should be part of every franchisee’s profile in your system.
- Communicate with the Landlord: Maintaining a positive relationship and prioritizing open lines of communication with the landlord will benefit the franchisor and business owner in the long run. Open communication will allow the owner to address issues and concerns efficiently, gain a better understanding of the lease terms, and will help in negotiating flexibility for potential lease agreement changes and modifications.
Seek Out Businesses for Sale in Your Expansion Markets
Financial pressure from rent delinquencies has a cascading impact. Without sufficient cash flow from existing properties and with rising interest rates, developers are slowing down efforts to bring new properties onto the market. Franchisors can offset this risk by looking at existing locations. The benefits of this strategy are:
- Faster Openings: With less new inventory, the time to launch for franchise brands will be slowed, resulting in more locations sold but not open on your books. This can place additional stress on franchisees and the operations team. Considering existing locations bypasses the need for new inventory, resulting in faster openings.
- Lower Initial Costs: Building from the ground up, using restaurants as an example, requires costly permitting and infrastructure like grease traps, commercial refrigeration, vent hood systems, etc. Meanwhile, fully equipped locations have existing infrastructure that can convert to your franchise concept. The cost to construct, permit, and open locations can be decreased using the strategy to acquire existing independent locations facing failure.
- Secure Leases at Favorable Rates: Leases signed today will be at the current rate, which is rising due to limited available inventory. Meanwhile, failing businesses may have leases signed pre-COVID with much more favorable rates and escalation clauses. The franchisee can acquire assets at a discounted value along with below-market rental rates.
Be Aware of Units Available for Sale Within Your Franchise
Franchisors should create an environment suitable for open disclosure and conversations around selling. With increasing costs and declining revenues contributing to the spike in rent delinquency, many business owners are faced with the difficult decision to sell.
- Embrace an Open Culture: It is critical to create an environment where franchisees feel comfortable discussing the sale of their business. An operator facing financial struggles may be embarrassed or fear the brand’s reaction if they want to sell. The brand’s culture must embrace those ready to enter and those ready to exit.
- Find Buyers Among Existing Franchisees: Franchise business consultants should discuss who in your system is ready to grow and who wishes to leave the brand. While consultants shouldn’t recommend pricing or negotiate deals, they should be able to connect those within the brand looking to expand with those who are ready to sell.
- Provide a Resource for Selling: Part of the brand’s culture of being open about sales includes vetting a third-party resource who can accurately perform valuations, act as a middleman in the transaction, and successfully locate new franchisees for any location looking to exit. A certified broker specializing in the restaurant industry can provide that service for many restaurant franchises. The same is true for specialized brokers in other industries.
About the Author
Robin Gagnon is the co-founder and CEO of We Sell Restaurants, a business broker franchise that specializes in the restaurant-for-sale marketplace.
Gagnon has appeared on The TODAY Show as a restaurant expert and was recognized by Nation’s Restaurant News as one of the country’s most influential suppliers and vendors. Her articles appear in QSR Magazine, Forbes and other industry publications. She is a regular media resource for all matters related to the restaurant industry. Gagnon has been named multiple times as the top 50 most influential people in franchising and Entrepreneur Magazine named her to the list of “Most Influential Women in Franchising.” She co-authored Appetite for Acquisition, a small business book award winner in 2012 and contributes frequently to industry press.
