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Developments in Franchising

Area-Development Pacts Boost Franchise Growth

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Agreements that give an individual exclusive rights in a territory are growing in popularity; capital market remains tight; industry lawyers set up a blog...and more.

They're back, and more popular than ever. Area-development agreements, which give an individual or group of investors exclusive franchisee rights in a territory--sometimes covering hundreds of miles--are becoming the expansion tool of choice for many franchisers.

Relying on one person or group to develop a large area can magnify the potential for loss, and the idea got a bad name when Boston Chicken, which had used it to proliferate in the 1980s, imploded. But now numerous franchisers, among them International House of Pancakes chain operator IHOP Corp., are building their growth strategy around well-heeled franchisees who are able to control an entire market rather than just a single site.

"It puts them in charge of their future," IHOP President Julia Stewart says of franchisees signing up to develop an area. In the past, individual store operators sometimes weren't sure whether another IHOP franchisee would open down the street. If they control the territory, that isn't a problem.

The company still decides how many units a developer will open and how quickly. "You may say I want to develop five units in five years, and I might reply you need to do it in three," Ms. Stewart says. Using area developers allows the franchiser to concentrate on operations. "We no longer are spending $150 million in capital a year to buy and build," she adds.

Other franchisers embracing area development include established companies such as Sonic Corp., the hamburger drive-in chain, as well as newcomers like Velocity Sports Performance, which sells athletic-conditioning programs.

The capital market remains tight for would-be franchisees.

"For new franchisees the best route is to go to an SBA lender," advises John Rinaldi, president of the Irwin Franchise Capital unit of Irwin Financial Corp. Many have already done so. "Our business is up substantially over the last couple of years in terms of numbers of loans," nearly 37% from last year alone, says Jim Hammersley, director of the Small Business Administration's Office of Loan Programs.

One reason for that popularity is the SBA Express program, which significantly shrinks the paperwork involved and speeds up the approval process for small-business loans.

But some would-be franchisees find it hard to obtain money anywhere -- among them those seeking money for convenience stores and gas stations. Both are facing heightened competition, and a scarcity of affordable environmental insurance for underground fuel tanks doesn't help. Those businesses led franchise loan defaults tracked by Fitch Ratings in 2002. "I expect it to be another long year" for them, says Adam Kaplan, associate director at Fitch's commercial asset-backed group.

Some franchise lawyers set up a blog.

While its emphasis is on legal developments in franchising, is a quick way to keep up on related news, including personnel changes, marketing innovations and even earnings reports by franchised companies.

Created by the Philadelphia law firm of Wiggin & Dana LLP, the blog--that's short for Web log or diary--is updated twice daily. Readers can link to the sources of the blog's snippets. There's no cost or password required.

Typical of blogs, this one doesn't separate the significant from the fluff. But the intent is to concentrate on the law.

A hotel franchiser finds no satisfaction in a Tennessee courtroom.

Promus Hotels sued one of its Hampton Inns franchisees to recover refunds Promus made to customers under a 100% satisfaction-guaranteed program. In addition to the price of a "make good" room, Promus had sought an "intervention" fee of $50 for each incident from the motel operator involved.

But a Shelby County Chancery Court judge agreed with the franchisee's attorneys, Dady & Garner of Minneapolis, that Promus had no contractual relationship with its franchisees' customers. So it can't recover money from a franchisee because of a guest's complaint. The decision was appealed and a spokeswoman for Promus's parent, Hilton Hotels Corp., said it doesn't comment on pending litigation.

A franchise called Bark Busters gives new meaning to the term on-the-job training.

The Australian company sells dog-obedience sessions, as well as "behavioral therapy" for problem pets and their owners. Franchisees work with dogs at clients' homes, dealing with everything from fence-jumping and excessive barking to territorial aggression and travel sickness.

"In the time it takes to watch a movie we can train your dog," says Andrew Brooke, president of Bark Busters' U.S. unit. The company guarantees its service up to the life of the animal, depending on the level of training purchased.

As for the concept's financial bite, franchisees pay $35,000 in upfront fees, then a 10% monthly royalty. They must meet annual sales quotas to retain their exclusive territories. Bark Busters' circular makes no claim for potential franchise profits. So far, about 24 have been sold in 10 states, Mr. Brooke says.


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