Multi-Unit Franchising: Navigating the Risk and Reward

While the saying “the more the merrier” is not usually associated with franchising, the rise of purchases of multi-unit franchises in the United States makes it more relevant than ever.

What is a multi-unit franchise?

A multi-unit franchisee generally purchases the right, and assumes the obligation, to open and operate a mutually agreed-upon number of franchise locations within a defined, exclusive territory over a specified period under an Area Development Agreement (ADA) with a franchisor.

It is common for the ADA to provide that a separate unit franchise agreement will be executed for each franchised location.

Traditional single-unit franchisees do not have the right or obligation to open multiple franchised locations and, in some cases, do not obtain exclusive rights in any area around their franchise location.

Conversely, in consideration of the multi-unit franchisee’s promise to open and operate multiple franchised units in their territory, franchisors generally agree that neither they nor other system franchisees will open additional franchised locations in that territory for the term of the ADA, so long as the multi-unit franchisee remains in good standing under the agreement.

Rewards of Multi-Unit Franchises

Franchisors and franchisees increasingly choose multi-unit agreements because they offer numerous benefits to both parties, including:

1. Faster Growth: With systems and management structures already in place, multi-unit franchisees can open multiple units more easily and quickly.
2. Efficiency and Cost Savings: Multi-unit franchisees benefit from their ability to buy supplies in bulk, lowering operating costs per unit. Franchisors save on the capital required for staff to support numerous single-unit franchisees.
3. Income Potential: Franchisors earn more royalties from a large number of stable units. More locations mean increased revenue and profit potential for franchisees.
4. Portfolio Diversification: Both franchisors and franchisees benefit by being able to target and capitalize on the various markets within broader geographic territories. And a franchisee owning multiple locations diversifies its revenue streams while reducing its dependence on a single unit.

Risks of Multi-Unit Franchises

With the rewards of a multi-unit franchise agreement comes some risk, including:

1. High Upfront Investment: Multi-unit franchisees must pay development fees for their exclusive rights in a territory in addition to initial franchise fees when entering a multi-unit ADA. Multiple units require a larger investment and more challenges in financing a multi-unit endeavor.
2. Over-reliance: Franchisors granting exclusive territories to a single franchisee leads to high dependence on the franchisee’s performance. Underperformance may damage the franchisor’s brand, and unit expansion can suffer. Likewise, a franchisee may become overly dependent on revenue from a single unit, which can jeopardize their overall success.
3. Reduced Growth Opportunities: Providing one franchisee with an exclusive territory in a multi-unit relationship limits the franchisor’s market flexibility. They would have a limited number of opportunities to offer opportunities to other franchisees, as well as increased difficulty reclaiming territory if the multi-unit franchisee underperforms.
4. Increased Complexity: Multiple units present franchisees with more moving parts, including staffing decisions and communication challenges across locations. There are more variables that can potentially go wrong. Franchisors must maintain brand consistency across multiple locations and meet the multi-unit franchisee’s more sophisticated business needs.

What should franchisors and franchisees know?

Franchisors entering multi-unit franchising must ensure interested operators have adequate capital and the business structure to manage multiple locations. Franchisees operating numerous locations must have the resources, continuous investments, and strategic approach for each unit to run optimally.

A reasonable development schedule is essential to the success of the franchise relationship in multi-unit franchising. These schedules outline how many units the franchisee must open, when the franchisee must open each unit, and include consequences for missing a deadline.

With thorough planning and open communication, multi-unit franchising can increase a franchisor’s brand visibility while enabling franchisees to build a more valuable business.

Experienced franchise counsel can effectively guide franchisors and franchisees through multi-unit franchise agreements, ensuring the opportunity for franchisee success and maintaining a mutually beneficial franchise relationship with the franchisor. Contact one of our franchise attorneys for more information.

Barry Kurtz is the Chair of our Franchise and Distribution Practice Group, a Certified Specialist in Franchise & Distribution Law by the State Bar of California Board of Legal Specialization. He has been recognized by his peers to be among the top 5% of attorneys nationwide for his work in franchise law in The Best Lawyers in America®.