“Franchising Expansion in South Florida: The Risks from Money to Politics,” an article authored by Adrian Felix and Mamie Joeveer, was published in Association of Corporate Counsel South Florida Focus Newsletter. You can view the full newsletter here.
South Florida emerged as one of the most sought after markets coming out of the COVID-19 pandemic. People flocked to the area, purchasing valuable real estate – both residential and commercial. Similarly, businesses like Blackstone, Starwood Capital Group, and Citadel have snapped up properties as they look to relocate their headquarters or open satellite offices in the area.
This migration of business and wealth to South Florida has fueled the expansion of the region’s franchising market. According to the 2022 Franchising Economic Outlook, Florida continues to be one of the top 3 states for franchise growth. Between 2020 and 2021, franchise establishments and employment increased in Florida by 4.2% and 10.3%, respectively, with the addition of 2,418 locations and 60,740 jobs. While that pace of growth slowed in 2022, the state’s overall growth rate of new establishments, jobs, and output, is still projected to exceed the national average for the year.
This means competition amongst franchise systems in South Florida will remain strong, as new and existing systems seek to expand their presence and as commercial landlords try to lure businesses to their new/improved retail spaces. Below are four key issues that franchises need to consider in deciding to embark upon an expansion to capitalize on the hot market.
Establish Who Should Be Responsible
Every franchise system is different, so how a particular expansion plan is handled can vary based upon the specific system and underlying agreement(s). For larger systems, unit updates/remodels and capital improvements are often clearly required to be performed by the franchisee, completed at a prescribed time (generally in tandem with renewal of the franchise term), and meet existing system standards. But that is not always the case for smaller systems and/or unscheduled improvements, and that ambiguity can result in messy disputes between franchisors and franchisees (and potentially third-party landlords).
Franchisors and franchisees should establish early on who will be responsible for coordinating (scheduled/unscheduled) unit updates/remodels. To that end, the parties should consider, inter alia, selection of the construction manager and contractor(s) (and whether there will be any special requirements or limitations to same), the need for regular project meetings or reports, the process for handling delays and/or budget overruns, and the process for requesting system variances.
Allocating these responsibilities gives franchisors the ability to ensure compliance with system/brand standards. Of course, the more control franchisors retain, the greater the risk of liability they assume. The foregoing responsibilities are also important from a franchisee (and landlord) perspective, because unit remodels/updates can impact operations (including, in some instances, necessitating extended store closures), and thus, can negatively affect revenue.
Assess the Economics of Expansion
Undertaking a single or multi-unit renovation necessarily entails some investment of time and costs. And, just like it is important to establish who is responsible for managing the improvement, it is essential the parties address the various financial components thereof early on.
First, the parties should discuss the anticipated renovation costs and agree on a maximum budget (or, at least, how the budget will be determined). Too often franchisors simply disclose static projections of the average or maximum renovation costs to franchisees, without sufficient discussion of those costs or the anticipated return on investment, and/or without due consideration of the potential for cost escalation over time. This approach commonly leads to claims against franchisors for violation of federal and state franchise laws, when the actual renovation costs spiral (not uncommon for construction in South Florida) and are alleged to far exceed the franchisor’s estimate, and/or when the revenue generated from the renovated unit does not meet projections, as argued in Burger Guys of Sunny Isles, LLC v. BurgerFi International, LLC (Fla. 15th Jud. Cir. May 21, 2021).
Second, the parties should agree on how unplanned renovation or relocation costs will be paid. Who will be responsible for cost overruns where the franchisor is directing the work? Will the franchisor and/or landlord assist with financing? Along those lines, it is worth exploring whether a remodel/update versus a relocation provides the best ROI, particularly as commercial landlords offer buildout allowances to retain or lure popular, franchise tenants.
Whatever the financing structure though, the franchisor should be comfortable that the investment costs are appropriate and the franchisee is well-capitalized, because the success or failure of the franchised unit will impact the franchisor.
Survey the Local Landscape
There is no substitute for being familiar with the local politics and rules in considering an expansion plan. As detailed in Bilzin Sumberg’s 2022 Guide to Developing and Investing in South Florida Real Estate, the area’s municipal and political landscape is complex and cannot be underestimated. For instance, COVID-19 rules varied between cities, counties, and the State during the pandemic, even in Phase 1 of Florida’s reopening when South Florida business services and activities were initially excluded by Executive Order 20-112. As a further example, a small Broward-based franchise expanding just over the county line into Miami-Dade may face new rules affecting zoning and employees, like section 11A- 28(10) of the Miami-Dade County Code, which was recently held, in White v. Autozone Inv. Corp., No. 3D21-598 (Fla. 3d DCA June 15, 2022), to create a private cause of action for employment discrimination against employers with five or more employees in the county. Franchises, therefore, must carefully consider the unique dynamics of South Florida’s governmental landscape.
Create a Paper Trail
Both parties should ensure any agreements reached on the above-considerations not only be reduced to writing, but also take into account their prior business dealings and agreements. It is easy for franchisors and franchisees who have been in business together for a long time to lose some formality in their relationship and proceed based on certain “understandings.” But, as the saying goes, fences make good neighbors, and “understandings” turn into disputes when the status quo is changed.
Expansion is necessary for a successful franchise system, but it is important to stay mindful of the risks involved and plan accordingly to enjoy all the benefits the South Florida market has to offer.