Business perspective
The company is the dominant vehicle in Australia and indeed throughout the world for conducting business. The company is an artificial creation of the law which confers on it the characteristic of being a legal entity in its own right – separate and distinct from its owners, its directors and its employees. It provides the opportunity for investors to pool their resources to exploit business opportunities without the need for them to personally manage the business and without personal liability beyond the extent of their individual investment (an advantage which in practice is balanced for the small thinly capitalised company by lenders requiring personal guarantees of the directors).
Australia has about 1.6 million companies, the vast majority of which are proprietary, or private, companies. Only about 10,000 are public companies and only about 2000 of these are listed on the stock exchange, the Australian Securities Exchange or ASX.
Many of the private companies are very small operations owned, managed and controlled by a single person and with paid-up capital of only $1. At the other extreme are the public listed companies with tens of thousands of shareholders, market capitalisation of billions of dollars and complex management structures.
Most franchisors in Australia are private companies as indeed are many franchisees. Private companies are nevertheless limited to 50 non-employee shareholders and cannot raise funds from the public.
Conversion to a public company allows unlimited membership and greater access to raising funds from the public. The most successful of these who can satisfy listing criteria may proceed to an IPO – an Initial Public Offering – through the ASX which facilitates, among other things, both the raising capital to fund growth, expansion or acquisitions and the orderly exit of the founders, early stage investors and family interests.
Several Australian franchisors are listed companies whose securities are publicly traded including Cash Converters, Competitive Foods, Dominos, Harvey Norman and Retail Food Group.
What then of the position of a franchisee of a public or listed franchisor? The obvious concern is that the interests of franchisees will be subordinated to the interests of shareholders. This is an argument which is invariably raised when a state asset is privatised and moves from public to private ownership – that shareholder pressure to maximise returns will result in reduced service performance. From a corporate law perspective the law is relatively clear. The directors owe their duties to ‘the company as a whole’ – to the general body of shareholders. Much attention is currently being given to the notion of ‘corporate social responsibility’ and the concept that directors duties are owed to other key stakeholders such as employees and creditors but CAMAC, the government’s corporate advisory body, has recently recommended that no change be made to the statutory duties of directors to include such wider social responsibility.
While franchisees can expect no special pleading under notions of corporate social responsibility, they are nevertheless in a stronger position than most other stakeholders.
Franchisees obviously have significant rights under the Franchising Code of Conduct and other regulatory instruments as well as under the franchise agreement itself. These legal rights are of course supplemented by commercial realities.
In a franchising organisation, corporate goodwill and profitability are directly and inextricably related to the performance of the franchisee network. A franchisor’s profit derives from the turnover of its franchisees. A franchisor’s reputation depends on the public face of the system which is largely dependent on the performance of its franchisees.
Franchisee dissatisfaction is a rampant virus that can quickly spread through a network. The domino effect is a strong restraint on inappropriate or ill-considered franchisor behaviour — particularly when all franchisees are affected as they would be when decision making is driven by shareholder pressure to the cost of the franchisee network. Issues affecting the entire franchise network cannot be quarantined.
The success of franchising is attributable to contributions of both the franchisor and the franchisees. The franchisor of course provides the brand, the system, the training, the ongoing support and development but the franchisees of course deliver at the coalface. It is a symbiotic relationship and is recognised as such by
successful franchisors.
Sustained franchisor profitability — and shareholder returns — ultimately depends on profitable, contented and committed franchisees and no substantial franchisor is going to take decisions driven by real or perceived shareholder pressure which threatens the viability of the franchise network.
In many respects a franchisee of a public company franchisor may be in a more advantageous position than the franchisee of a smaller private company. The short history of Australian franchising is littered with examples of small systems which have not thrived, or, in some cases, survived.
Entrepreneurs may be able to establish a business but may not necessarily be equipped, financially or managerially, to drive it forward beyond critical mass for the benefit of all stakeholders.
A public company not only has access to public funds for development and expansion — perhaps through the acquisition of competitors — but can attract specialist management and directors who can add real value.
Public companies are also subject to higher levels of financial disclosure unlike small private companies which are largely exempt from audit and reporting requirements. For listed companies the ASX Listing Rules set out even higher standards, not only for initial listing but also to maintain listed status. For a prospective franchisee the level of financial disclosure available in respect of a public/listed company enables more effective due diligence.
While the contribution of the massive US franchising pioneers such as McDonaldÕs, KFC and Pizza Hut to the development of the Australian franchise sector cannot be discounted it has been the entrepreneurship of hundreds of committed individuals who have built franchise companies which underpins the diversity and strength of the sector. Each of these entrepreneurs started business through the private company structure and the vast majority of Australian systems still remain in private hands albeit not always with the same ownership and increasingly with better management and corporate governance.
A much lesser number have converted to public companies and fewer still have listed. It would be surprising if the status of the franchisor’s corporate vehicle was a deal breaker or a deal maker for a prospective franchisee.
Andrew Terry, Professor of Business Regulation, Faculty of Economics and Business, The University of Sydney and
consultant to DC Strategy