As global interest in American products and lifestyles continues to rise, many U.S. brands are looking beyond their home turf for growth. Franchisors, in particular, are well positioned to tap into these international opportunities, but before jumping into overseas markets, it’s crucial to navigate the unique business, cultural, and legal challenges that come with global expansion.
Careful planning can make all the difference in ensuring success. A key priority is in identifying the best markets for expansion and choosing the right partners to collaborate with. Not every international market is a good fit for every brand, so an understanding of local landscapes is the first vital step. Franchisors need to carefully analyze factors such as consumer demand, cultural compatibility, economic stability, and regulatory environments.
Other vital initial steps in expanding internationally include selecting the right business partners and entity structure, as well as conducting a thorough analysis of applicable U.S. and destination country laws. Once the system is up and running abroad, the U.S. franchisor should continuously monitor its international operations to ensure that local franchisees are appropriately recruited, suitable sites are chosen for the franchised businesses, and all parties involved adhere to the franchisor’s brand standards.
The right local partner can help a U.S. franchisor navigate everything from customer preferences to regulatory challenges, while a poor choice can lead to delays, legal headaches, or worse. Cultural fit matters too – local partners should bring not only capital to the table but also experience in the market and a deep understanding of how the U.S. brand can be adapted for local consumers. In-depth market research and even small pilot operations can help test the waters before committing to a full-scale rollout.
Brand protection
Trademark protection is a primary consideration for any brand owner seeking to expand abroad. Does the trademark used in the U.S. resonate culturally in the destination country? Has the U.S. franchisor registered its primary trademark there? If not, should the franchisor register the exact same mark, a variation of it, or a different mark? Franchisors must ensure that their marks are protected not only from imitators but also that the destination country’s laws allow for injunctive relief to stop the franchisee from continuing to use the mark after the agreement ends. If they don’t, what contractual or business strategies should the franchisor employ to address these issues?
In some countries, local laws may not offer the same level of protection as in the U.S., so franchisors should consider incorporating contractual safeguards that can mitigate these risks. In some cases, the franchisor might consider limiting what intellectual property is disclosed to franchisees.
Cultural sensitivity is also required when determining whether the U.S. trademark will resonate in the destination country. A case to bear in mind is the Chevy “Nova,” which translated to “doesn’t go” in Spanish-speaking countries.
Different models
Structurally, franchisors have several options for setting up operations abroad. One way is through a master franchise arrangement, where the master franchisee (who becomes the franchisor or developer abroad) operates independently of the franchisor. Here, the franchisor grants the entity in the destination country the right to issue franchises locally, making the individual franchisees essentially sub-franchisees of the U.S. company.
Alternatively, both parties can create a joint venture entity, owned by the U.S. franchisor and one or more owners in the destination country. If a joint venture is chosen, it could be used to test the concept or to create separate entities that operate test units before forming a company to grant franchises. The U.S. franchisor’s foreign partners will staff and manage the operational entities abroad, overseeing local franchisee recruitment, training, and support while ensuring that the U.S. franchisor’s business model and practices are effectively adapted to the local market.
A jointly owned entity allows the U.S. franchisor not only to receive a share of the revenue but also to enjoy potential upside from an equity stake in the venture. A ‘subordinated equity arrangement’, where the U.S. party has less control than in a traditional joint venture, is another option. In these arrangements, the foreign partner might initially hold significant operational rights while the U.S. franchisor takes a more passive role in day-to-day management. However, the franchisor retains the option to buy back or significantly increase its equity stake later, based on negotiated milestones. These arrangements are typically customized and require careful input from experienced legal counsel.
Using the area developer model, the foreign company expands the brand in the destination country by opening unit businesses itself or through its affiliated companies. This approach might avoid the need to comply with franchise laws but requires a well-capitalized foreign partner that can afford to grow organically. Development agreements typically include a schedule outlining the number of locations the developer must open within a specified timeframe, ensuring multiple units become operational in the agreed period.
Supply and demand
Product supply is another consideration that requires careful planning. Sourcing equipment, supplies, or inventory from within the franchisee’s country might be advantageous due to import prohibitions, quotas, significant duties, or the perishable nature of goods, or simply because they are less costly if purchased locally.
Additionally, U.S. law restricts the export of certain goods to specific countries. If the goods are sourced by an approved foreign supplier, the franchisor must oversee quality control and may need to establish separate license or manufacturing agreements. The currency of payment to the U.S. franchisor requires foresight too. If payments are to be made in U.S. dollars, a currency conversion clause will be necessary. In countries with weak currencies, central bank approval may be required, and there may be limits on the amount that can be paid in U.S. dollars.
U.S. franchisors are already familiar with the Federal Trade Commission (FTC) rule, which requires them to provide a detailed Franchise Disclosure Document (FDD) to prospective franchisees in a specific format, as well as state laws that require state-level registration of franchise offerings. In comparison, many other countries have fewer disclosure requirements, but franchisors may face greater challenges in terminating franchise arrangements. In many countries, these relationships are classified as ‘distributorships’ and protected under laws that limit the U.S. brand owner’s ability to end the relationship.
U.S. franchisors must also navigate a variety of federal and state laws imposing specific requirements on franchisors expanding abroad. For instance, the U.S.A. PATRIOT Act and anti-money-laundering laws can significantly impact the due diligence process, while the Foreign Corrupt Practices Act (FCPA) may come into play if a foreign franchisee uses government-related ties to secure, in a manner prohibited by the FCPA, certain contractual rights in the granted territory.
Additionally, expanding U.S. economic sanctions must be carefully considered before making contractual commitments – particularly in regions affected by conflicts, such as Ukraine and parts of the Middle East and Africa.
As an example of how state law can impact international deals, a U.S. franchisor based in New York must be aware that the New York Franchise Sales Act (NYFSA) applies whenever a franchise offer is made or accepted in New York, even if the franchisee is located outside the state. The NYFSA requires franchisors to register in New York and provide an FDD to potential franchisees worldwide, often necessitating significant revisions to the franchisor’s existing FDD to tailor it to a foreign market. This process can be costly in terms of both time and expense for what may amount to a single, unique transaction.
Franchisors can request a discretionary exemption for such non-U.S. franchise sales, which the New York Attorney General’s Office typically approves when properly presented, but this too involves additional costs. Additionally, many countries now have their own franchise laws, including Australia, Belgium, Brazil, Canada, France, Indonesia, Korea, and the Netherlands, and U.S. franchisors must familiarize themselves with these local laws to ensure compliance.
Effective negotiation
By seeking the right legal guidance, U.S. franchisors can significantly improve their chances of mitigating risks and building a sustainable, profitable international presence. Before presenting agreements to potential partners, U.S. franchisors must ensure that these agreements are approved by both their U.S. legal team and local counsel in the destination country.
While negotiated franchise agreements are uncommon in the U.S., they play a crucial role in international deals due to differences in laws, unique factors in each arrangement, and the importance of the area development or master franchise agreement to the franchisor’s overall strategy. Additionally, the prospective foreign partner is likely to be a significant company with some bargaining power.
Although unit franchise agreements may not be heavily negotiated once the system is operational, their terms are often discussed during the negotiation of the master franchise agreement. Effective negotiation is key to achieving a mutually beneficial outcome for both the franchisor and franchisee. A well-drafted and carefully negotiated agreement can lead to profits for both parties and help minimize the potential for future disputes.
