Joint Venture and Franchise Agreements Analysis

A joint venture is an art which takes place when two parties come together to take on one project. In joint venture both the parties invest equal money, time and effort to build on the original concept. Joint ventures are small projects but some major corporation also uses this method to diversify. A joint venture ensures success to those business concerns which are new to the business world. Since the cost of starting new projects is generally high, joint ventures allow both the parties to distribute the burden of cost, time and effort.

Joint venture agreement

It is a contractual agreement between two or more business partners to assume a common business strategy on a project. All partners usually agree to share the profits and losses through their common shareholdings.The objective of the major concerns today are to become an important assets for any corporation. This is particularly relevant in the global context where the ability to create and sustain collaborations is important in concerns holding a competitive advantage.

It has become a regular and important activity in companies to devote their more time in screening out the potential partners in financial terms. Joint ventures demands trust, honesty, integrity, communication, care and vision if the alliances wants the long lasting relations. It has been found that North American companies are more concerned with the economies of the deal rather than on human aspects whereas in Asian countries more pressure is put on inter-personal relationships.

1. Holmes & Lofstrom (2003), “The advantages and disadvantages of Franchising”, Holmes & Lofstrom, LLP

Nature of joint venture

Joint ventures may be either contractual or structural, or both. They may be broad based or narrowly defined. Long-term joint ventures, particularly broad based are best suited for a corporate structure. Corporate joint ventures are characterized by shared ownership and often shared functions such as research and development, manufacture, assembly or marketing. Shared ownership leads to shared governance and shared dependency. The success of joint ventures depends on:

• a common strategic vision
• a strong commitment by both parties
• providing business contributions by the parties which are complementary.

Need of joint venture

In today’s competitive world, projects are too large that any company fails to undertake the huge burden of financial commitments. Market access also adds to the reason for the international proliferation of joint ventures .Conducting research is another area where the risks need to be shared. Apart from generating profits for both parties, the parties must implement their vision for the future and exploit unforeseen opportunities.

2. Gregory G. (2007), “Fundamentals on Joint Venture”, Branzburg & Ellers LLP

The stages of establishing a joint venture

The process of joint venture is as follows:

Selection of partner: It is one of the most important and risky step to identify the appropriate partner and open up a dialogue to explore mutual interest without any firm commitment. The selection based on some features:

• long term commitment to the industry and venture
• value added should be complementary by the parties.
• experienced
• adequate financial strength
• strong local market presence

The negotiation phase : In this phase, the partners focus on the potential problems in the parties future relationship. Some of the issues are:

a) Agreement over business plans

b) Probe into the inadequacies and weaknesses of each partner

c) Full documentation-confidentiality agreement, technology transfer, technology licensing, patent or trade mark licensing, supply of machinery etc.

d) Decide the dividend policy.

e) Extent of ownership of each party

3. Donald W (1979). “The international expansion of US franchise systems: status and strategies”, Journal of International Business Studies 1976 Palgrave Macmillan Journals.

The execution phase: This stage involves putting up the project within the shortest time period. This phase needs a great deal of team spirit among the partners .The technical information actually starts from this stage. Disputes may arise on equipment pricing, on quality of assigned personnel, technological changes or adoptions found in actual practice.

The operations phase : This phase is also called as realization phase. Operational phase includes a high level of maturity at the senior most levels. In this phase the problems which may be predicted are:

a) Market projection may not materialize,

b) product cost may overrun

c) process efficiency may not be at projected level

d) performance may lack behind expectations.

Detailed visionary perspectives should be build to bring solutions and success.

The maturity phase : In this phase the sustained as well as continuing alliances update and modify the contents and take continuous reports of changing market requirements.

Documentation Required

The important document required under joint venture is joint venture agreement. This agreement includes the method of formation of joint venture company as well as sets out the mutual rights and obligations of parties for the purposes of conducting the joint venture and the manner in which the parties will conduct themselves in operating and managing the JV company. The following major points are usually incorporated in a JV agreement:

4.Gregory G. (2007), “Fundamentals on Joint Venture”, Branzburg & Ellers LLP

Parties to JV agreement: The oversea company that is the original party may not be the actual investor in the joint venture.

Objective and product : The most important clause which briefs out the main objective that is business to be carried on in all as well as specifies the territory in which it is proposed to be carried on.

Formation of JV company : This clause explains the registration of the new company under companies act or converting the existing company into a JV company. It also spells out the manner in which the cost and obligations will be shared.

Registered office : In this clause the location of JV business and the registered office of the company, both of which can be at same place is mentioned.

Investment of capital participation : The extent of shareholdings of both the partners is defined in this clause .The share capital may be allotted in an agreed ratio by investing cash or by bringing in infrastructure facilities, services and assests like land & building, patents, trademarks, goodwill etc

Arrangement of funds : This clause states the methods of raising out the finance. It also provides whether any party is required to give guarantees for raising the finance.

6.Donald W (1979). “The international expansion of US franchise systems: status and strategies”, Journal of International Business Studies © 1976 Palgrave Macmillan Journal

Specific obligations : This clause states the details of specific obligation of each party to run the JV company such as:

grant of technical assistance and know how

providing marketing expertise

market research, innovation and product improvement

Agreement of issue of capital

This explains the ratio and terms upon which the parties would further subscribe for the issue of share capital. It also spells out the situation where one party is unable to bring out funds due to any reason.

Appointment of directors

This clause sets the composition of BOD .the change in the composition of Board in the event of change in the pattern of shareholding, provisions for alternate directors, naming of managing director and the Chairman, remuneration etc .

Conduct of affairs of the JV company : This clause includes the timings of meetings, notice agenda, frequency of meetings, audit structure, etc.

Transfer pricing : This clause spells out the transfer pricing policy in cases where the JV company buys raw materials, components, parts, semi finished products from the JV partners.

7..Donald W (1979). “The international expansion of US franchise systems: status and strategies”, Journal of International Business Studies © 1976 Palgrave Macmillan Journals.

Share transfers : In case of termination of agreement in any circumstances, this clause provides the manner of share transfer .In general, if any partner wants to dispose its shares it will come under an obligation to transfer its shares to the other party. This act will eliminate the risk of an unacceptable third party (competitors) from taking undue advantage. If other party refuses to buy the shares, the seller may appoint the third party but the price offered to the third party will be lower than the original price.

Dividend and distribution policy : In this phase it is set up that how much ratio of profits will be distributed as dividends among the parties and how much profits will be kept as reserves for future uncertainties

Brand licensing Agreement : If the name of the one party or the brand name of the product enjoys the goodwill and reputation then both the party agree to permit the use of existing name or the brand name of its product by the JV Company.

Research and development : This clause explains the method of improvements and innovations carried out by any one of the parties to the agreement.

Non Competition provisions : The following points are mentioned under this clause:

Parties to the agreement will only carry out manufacturing and marketing activities only through the JV company.

no party shall carry on similar business for an agreed period after termination.

8..It is not necessary, of course, for all of these elements to be present. It would be sufficient for a significant number to be present in order for the arrangement to qualify as a joint venture as the term is used in this paper.

Confidentiality : The agreement made between the parties should be kept confidential because it contains the information related to the technical process, business, know-how and other business information .

Period of agreement : This explains the time period of agreement which would remain in force so as to bind the parties together .Effective date of commencement of business is also stated. It also spells out the renewal date of agreement if situation call for.

Termination : This clause explains the conditions of termination of JV agreement

Mutual agreement of the parties

breach of contract by one party

breaking and manipulating rules and terms of agreement.

Force Majeure : This clause provides protection to a party with events beyond its control which disable any party from performing its obligations under JV agreement.

Preliminary expenses/pre-operative expenses : Ratio of bearing of priliminary expenses are detailed in this clause.

Arbitration : If the parties fail to resolve their disputes through negotiated settlement, a provision for arbitration is required as last alternative. Arbitration clause provides the forum other than a court of law so that disputes may be resolved.

Governing law : This clause stipulates the system of law by which the agreement is to be incorporated and enforced.

Assignment : This clause explains the assignment of agreement to the nominee or the successors.

9.Brent McKenzie, (2002) “International Franchising in Emerging Markets: Central and Eastern Europe and Latin America”, International Journal of Service Industry Management, Vol. 13 Iss: 3, pp.303 – 308

Franchising

A form of business organization in which a firm already has a product or service (the franchisor) enters into a continuing contractual relationship with other businesses ( franchisees) operating under the franchisor’s trade name and usually with the franchisor’s guidance ,in exchange. It simple words, it is a method of entering into a franchise agreement wherein two parties agree to do business with contractual provisions. The setting would be, one party has an idea of the business while the second party will do the business of the other party and pay for its name and reputation.

The advantages and disadvantage of franchising

This memorandum, produced for a number of our clients considering franchising, bring together the advantages and disadvantages of moving to a franchised system of operation.

Disadvantage of franchising

Higher Legal expense The expenses on preparing agreements, uniform franchise offering circulars (UFOCs), and related documents ,and filling them in various states includes a significant expense, although the year to year expense are usually less than those of initially incurred in setting up the structure and related documents. Basic documents once prepared can be used with minor changes in other states. If separate legal entity is used for the franchising program, additional cost has to be incurred.

10. Bruce Kogut (1998), “Joint ventures: Theoretical and empirical perspectives”, Strategic Management Journal Volume 9, Issue 4, pages 319-332, July/August 1988

Technical legal constraints

Franchise award process

Laws of franchising are particularly technical in their application, for example ,if a franchisor provides 9 days of pre-sale disclosure rather than 10 days,the franchisor gets the automatic rescission right. For these reason, franchising program for franchising personnel and assistance of in house legal compliance person is highly useful.

(b) regulation of the relationship

In many states the franchisor terminates or refuse to renew a franchise in number of circumstances. If franchisor fails yo achieve the termination or renew the agreement,then these laws provides a number of technical requirement that must be followed .these laws stated provides the solutions for getting termination and renewal.

Franchise marketing constraints Various expenses like advertising, brochures, flip charts,video tapes,etc offering the franchise must be pre-cleared with the state agencies and cannot contain earning claims.The formal document attached to the UFOC only details the information regarding financial results

Control issues Quality control and other related issues are there. Various issues are discussed as below:

11..Donald W (1979). “The international expansion of US franchise systems: status and strategies”, Journal of International Business Studies © 1976 Palgrave Macmillan Journals.

Business relationship issues

Franchisees view themselves as to some extent, partners with the franchisor in the development and possible success of the system. Most of the committee ill see that they should be ONE captain for the ship that is one person should be responsible for the success of the system. For example Franchisor will work with his franchisee, with the help of franchise advisory council, he will take strategic decision and will implement marketing plans. A franchisor always works psychologically and works comfortable with his colleagues, franchisees who can understand the franchisor properly.

Delivering perception

Franchisees are the people from whom we can expect that they are very experienced for running the business (on retail level) .Only these experienced people can bring the business at a profit because they are being asked by the contributor about what he long term profit plans. Franchisor build the value of the brand y updating systems and providing continued operational and marketing benefit gives the franchisee the superior position that is the competition between making his/her leaving the system on a poor business. By giving the business at profit franchisee delivers a perception to his senior that he has the capacity and capability to run the business profitably

Potential for loss of freedomFranchisor seeks to expand his business through alternative channels of distribution that is internet ,mail order etc and also through special venues like wall mart K Mart etc. Proper franchise agreement shouldbe made and provisions should be fulfilled that any legal or other other problems does no arise at all.

12.Brent McKenzie, (2002) “International Franchising in Emerging Markets: Central and Eastern Europe and Latin America”, International Journal of Service Industry Management, Vol. 13 Iss: 3, pp.303 – 308

Finding qualified Franchisees

A good franchisee is difficult to find because there are many dealers who are not educated due to this dealers should be educated by providing proper training and they should themselves be able to work hard and act as a team player. While selecting the franchisee the psychological testing and detailed interview and training process are tools which are used to select the right individual. The question here arises is that the candidate selected is right or not to act as a franchisee.

Unmanaged growth:

Unmanaged growth is there only when the franchisee does not work properly or negligibly without putting any efforts into the contract. The potential downside is too rapid expansion.

In short following are the disadvantages from the point of view of franchisor as well as franchisee:

1. Considerable capital allocation is required to build the franchise infrastructure and pilot operation. At the beginning of the franchise program, the franchisor is required to have the appropriate resources to recruit, train, and support franchisees.

2. the beginning of the franchise program there is a broader risk that the trade name can be spoiled by misfits until such time the franchisor is capable of selecting the right candidate for the business.

3. There is a risk that franchisees exercise undue pressure over the franchisor in order to implement new policies and procedures

5.Donald W (1979). “The international expansion of US franchise systems: status and strategies”, Journal of International Business Studies © 1976 Palgrave Macmillan Journals.

4. The franchisor has to disclose confidential information to franchisees and this may constitute a risk to the business.

Disadvantages from the point of view of franchisee

1. The requirement to pay the franchise fees and royalty to the franchisor, which in some cases can be exaggerated.

2. The transfer of all goodwill built in the local market to the franchisor upon expiration or termination of the franchise contract.

3. The necessity of abiding by the franchisor’s operating systems, standards, policies and procedures.

4. Reduced corporate profit margin due to payment of royalties and levies.

Advantages of Franchising:

Ownership mentality

Similar to a dealer, a franchisee agreement is made which is a long term agreement. The franchisee have an attitude of being a business owner as such he is more likely to devote time,attention and capital to grow the business by following the approved concepts and system and not walking away from any business challenges. Franchising deals with many products and not with a single one. “There is a general saying that a good fertilizer help to grow crops easily”.

.Donald W (1979). “The international expansion of US franchise systems: status and strategies”, Journal of International Business Studies © 1976 Palgrave Macmillan Journals

Building up value

Value is being build up when the proper distribution system is there ,when strong brand identification is there covering both the products offered and the retail business operated. Assuming that a brand recoginition is there is to be set in the mind of the consumers,the following benefits flows into the franchisor and its franchisees. These advantages have two primary points (1) prominent identification of each retail business with the trademark and(2) a strong retail marketing campaign building brand identity in the consumer’s mind.

Easier franchise sales ( both individual units and area development arrangements)

Clustering units to achieve dominant local presence.

Easier retail sales for franchised and company owned units.

Higher initial franchise fees.

Higher royalty levels.

Ability to leverage brand identity and require franchisees to finance marketing campaigns.

Higher wholesale and retail prices for product.

Fewer “breakaways” from the system.

Regional and national market penetration, with establishment of dominant market share.

Greater value when he Franchisor goes public or otherwise realizes the value attached to the brand.

11.Bruce Kogut (1998), “Joint ventures: Theoretical and empirical perspectives”, Strategic Management Journal Volume 9, Issue 4, pages 319-332, July/August 1988

Greater value for franchised units irrespective of the owners personal involvement or skills for example, A McDonald has a relatively constant value, due to the brand, independent of who the owner or manager of a particular unit is).

Easier access to lenders and other financing sources.

Easier access to desirable locations and favorable lease terms.

Increased barriers to entry by competitive concepts.

Image

Franchise systems generally have a superior image other from the distribution channels, if there is a uniformity as to retail presentation, marketing methodology, operational compliance, etc.

Franchise Participation and Support:

Although it is not unique to franchising, franchisee participates in the business for the expansion of the business and proper operatins of entire enterprise by producing new and creative ideas as well as resolving all the problems which comes under the process. This is the physocological advantage that can develop among franchisee ,and if properly managed a team participation can manage the entire system. SYSTEM WIDE MARKETING SUPPORT PAID BY FRANCHISEE

System of franchising basically includes arrangements where national marketing fund is been managed and participation in local marketing cooperatives supporting retail marketing, advertisement, promotions and public relations. This ability of the franchisee produces competitive advantage including raising barrier to entry of potential competitors as well as the entry of already leading companies in the industry.

.Donald W (1979). “The international expansion of US franchise systems: status and strategies”, Journal of International Business Studies © 1976 Palgrave Macmillan Journals

IMPROVED CONTROL OVER OPERATIONS AT THE RETAIL LEVEL

Franchising provides both legal and institutional structure allowing detailed control over the individual units marketing and operationl programs. Every unit should follow recommended marketing and operational guidelines as it provides the strongest methods of achieving that objective.14

AVOIDANCE OF LEGAL EXPOSURE

As we know that our system is currently a “quasi-franchise” we face exposure to both states and federal enforcement as well as claims for recession ,damages and attorney’s fees for non compliance or business opportunity registration and disclosure law.This exposure exist not only with the current dealer but also with the present dealer.

The unsuccessful dealer always avoids challenges due to which business is being affected. Registration as a franchisee also removes the necessity in at least some states to register as a business opportunity. Business opportunity laws offer require unfavorable provision in contract allow recession during a “cooling off” period and place the company in the same category with those who are offering vending machines deals and worm ranches, a group may want to distance yourselves from.

Additionally, compliance with disclosure requirements often act as a type of “insurance” on the basis that if a fact is to be disclosed to a prospective franchisee it becomes far more difficult for the franchise to later claim he/she did not know of the unfavorable fact in question.

..Gregory G. (2007), “Fundamentals on Joint Venture”, Branzburg & Ellers LLP

At last franchising document provides area of special protection to the franchisor including the following:

Franchisee is required to purchase designed products and equipment only from approved supplier which may be limited to the franchisor and or to its affiliates.

If franchisees purchase item from unauthorized sources , limitation on sources of supplies is unenforceable, royalties are imposed which are adjusted upward substantially to make up for lost revenue at the Franchisor/affiliate level.

If franchisees do not meet sales/ product purchase quotas ,they can loose their territorial rights and can be terminated And or ineligible for renewal.

If we are uncomfortable with the working relationship with the franchisee you can at the same time implement a friendly divorce by returning the initial franchise fees, the franchisee return all equipment

Franchisees contribute to a national marketing fund and are required to join, and contribute to, local marketing co-ops.

Releases by the franchises of all known and unknown claims against the franchisor or any affiliates are compulsory on assignment.

all disputes and jury trail is resolved by binding arbitration/mediation at the Franchisor’s headquarters by the experts.

Damages paid by the franchisee, shortens statutes of limitation.

In nutshell following are the advantages to both FRANCHISOR as well as FRANCHISEE.12

.Donald W (1979). “The international expansion of US franchise systems: status and strategies”, Journal of International Business Studies © 1976 Palgrave Macmillan Journals

FOR FRANCHISOR:

1. Financial: Franchising creates another source of income for the franchisor, through payment of franchise fees, royalty & levies in addition to the possibility of sourcing private label products to franchisees. This capital injection provides an improved cash flow, a higher return on investment and higher profits. Other financial benefits that the franchisor enjoys are reduced operating, distribution and advertising costs. Of course that also means more allocated funds for research and development. Additionally, there will always be economies of scale with regard to purchasing power.

2. Operational: The franchisor can have a smaller central organization when compared to developing and owning locations themselves. Franchising also means uniformity of procedures, which reflects on consistency, enhanced productivity levels and better quality. Effective quality control is another advantage of the franchise system. The franchisee is usually self motivated since he has invested much time and money in the business, which means working hard to bring in better organizational and monetary results. This also reflects on more satisfied customers and improved sales effectiveness.

3. Strategic: To the franchisor, franchising means the spreading of risks by multiplying the number of locations through other people’s investment. That means faster network expansion and a better opportunity to focus on changing market needs, which in its turn means reduced effect from competitors.

4. Administrative: With a smaller central organization, the business maintains a more cost effective labor force, reduction of key staff turnover and more effective recruitment. 13

.

Holmes & Lofstrom (2003), “The advantages and disadvantages of Franchising”, Holmes & Lofstrom, LLP

FOR FRANCHISEE

1 .Lower financial risk, compared to other ventures, because investment costs are lower and profit margins are higher.

2. Business Format Franchising complete packages ensure a ready to go “turn-key” franchised unit.

3. Managing a small business whilst depending on the power of the franchisor company which has a bigger organization.

4. The franchisee has an opportunity to run a proven business concept with a successful operational track record.

5. The opportunity to learn the latest developments and changes in the local and global market from the franchisor and focus entirely on developing the sales revenues.

6. The benefit of operating under a recognized trade name/trademark, which can have better marketing results. 14

7. The franchisee has access to accumulated business experience and technical know-how in managing the business. 15

14.Mazumdar M (2007), “Fundamentals on Joint Venture”, Majmudar & Co., International Lawyers, India

Conclusion

This paper has examined every corner of the Joint Venture and Franchise agreement. In this way, we can explain that joint venture is a venture between two or more parties to take economic action together and both are having control over the organization and also agrees to establish a new entity by agreed contributing expenses. This could be project specific or for the long term business venture. And when two or more parties agree to pursue a set of goals to meet critical business needs while being an individual entity is known as Franchise. Strategic alliance with resources such as distribution channels, products, manufacturing capability, capital equipment, knowledge, project funding, expertise, or intellectual property may be provided by partners. Hoping that the benefits from alliance will be higher than that of individual efforts, partners enter into strategic alliance.