To say 2024 was challenging for the restaurant and hospitality industry would be something of an understatement.
The hospitality industry is reliant on discretionary spending, and the cost-of-living crisis placed significant pressure on an industry still recovering from the pandemic. The Autumn Budget did little to provide the boost the industry has been waiting for; with rates reform kicked down the road and further cost pressures on their way.
It’s estimated that 46% of consumers intend to cut back on spending on dining out in 2025. Then there’s the double whammy of a reduction in the employers’ national insurance threshold and the increase in contributions, which will mean an additional 774,000 workers will be eligible for employer NICs costing the sector £1 billion, according to estimates published by industry body UK Hospitality. Coupled with an increase in the minimum wage and the abolition of zero hours contracts, we expect many operators to re-evaluate their roll out plans.
Roll outs are expensive after all, you’ve got rent, rates, service charge, insurance, fit out costs and SDLT even before you open the door and hire your first employee!
As the country’s third largest employer, the hospitality industry contributes over £93 billion to the UK economy each year; if the industry takes its foot off the gas, it will impact the Government’s growth agenda.
But what if there was another way to continue rolling out? Enter the franchise...
Franchising is a business model where a franchisee acquires the rights to operate an established brand and replicate a successful business operation?
The recent British Franchise Association (“BFA”) Journal provides suggests that the UK is currently home to 1009 franchise systems (an 8% increase on 2018) operating from a total of over 50,420 units (a 4% increase on 2018) but we are a long way behind the US where there were an estimated 792,000 franchise outlets in 2022 employing almost 8.5 million people.
Franchising is prevalent in the QSR sector but presents opportunities for restaurants and grab and go operators alike.
For a franchisor the biggest opportunity has to be the ability to reduce the capex required to open new sites as you can structure your franchise in such a way that the franchisee takes on all of the “risk” associated with a new site. Operators can either go full steam ahead and switch to a wholly franchised model, where all new sites are franchised; or a blended model of some company owned and some franchised sites. Less risk means that franchisors may be able to expand into what would have previously been considered more marginal areas if they are able to find a franchisee willing to take on that location.
Whilst there are definite benefits to the system franchisors need to ensure they put in the initial hard work to set the business up for success.
From a practical perspective, you’ll need to put in a rigorous selection process for your franchisee as they are the ones driving the business, this isn’t a passive income. You’ll want well-funded operators with the BFA suggesting that 71% of franchisee candidates rejected in 2024 due to insufficient funds.
As you are licensing the intellectual property (“IP”) and know how of the business it’s important that these have been adequately protected and documented. Brand guidelines and operational manuals need to be robust to ensure continuity across sites while the franchise agreement needs to have sufficient weight to it to ensure that a franchisor can step in and put things right if a franchisee decides to step outside of the franchise agreement either by varying the offering or breaching brand guidelines.
When it comes to the legal side of things operators should give some thought to the most efficient structure for the business, should the franchise side be kept separate from the corporate owned stores? Do you want the IP to be held by a top co and licensed to all operators?
If a franchisee is taking the site in their name franchisors need to ensure that they are able to secure a premium site from a franchisee if the franchise agreement is terminated. This can be achieved by either the franchisor taking the site and subletting to the franchisee, although this may negate a large proportion of the capex saving as the franchisor would ultimately be responsible for rent, rates, service charge and SDLT on the premises; or by providing that a transfer of the property from a franchisee to a franchisor is automatically permitted under the lease.
This sounds great... so why aren’t more people doing it?
Franchising is definitely on the rise, and for entrepreneurs and potential franchisees, the opportunity to acquire an established brand and hit the ground running with a proven business model and support from those who have been there and done it somewhat derisks the venture.
Existing operators can also diversify their portfolio by offering additional brands, something we’ve seen recently with the likes of Boparan Restaurant Group and Azzurri Group respectively bringing Carl’s Jr and Dave’s Hot Chicken to the UK.
Before launching into acquiring a franchise, potential operators need to be prepared to adhere to the systems set out by the franchisor which may limit their ability to innovate or adapt to the local market. Franchisees need to factor the initial franchise fee, royalties and marketing spend into their P&L forecast which could impact on site profitability.
So, is 2025 the year franchising goes mainstream in the UK?
I certainly think it’s the year it goes mainstream as headwinds look set to continue, and operators will need to adapt their business model to ensure they continue to thrive.
While franchising may not be the silver bullet, it does provide both operators and entrepreneurs with an alternative to traditional roll outs. Both parties just need to go into it with their eyes open and take advice on how to protect their assets and implement the best structure for the transaction.
Alex Hutchings, Partner, Head of Real Estate, Greenwoods Legal LLP
Email: amhutchings@greenwoods.co.uk
LinkedIn: Alex Hutchings | LinkedIn
