Franchises in Ukraine. How to invest and not fly

An investor analyzing the Ukrainian business environment is increasingly encountering proposals to invest “in franchises”. In theory everyone seems to understand what we are talking about, but in practice everyone puts their own expectations into this phenomenon.

Despite the legal intricacies, it is an interesting tool, and our task is to explain the basic points that an investor should take into account before starting cooperation with Ukrainian companies through the acquisition of a franchise.

You can see the basic concepts in franchising here, and in this article we will talk about the practical aspect of working through a franchise in Ukraine.

Standard commercial concession agreement in Ukraine

Imagine a successful retail network (stores, food establishments, etc.) that has made a name and has a working business model. This network should expand, which it does with its own funds and loans.

The network can also offer other private entrepreneurs to buy its “franchise”: the investor receives the right to use the company’s achievements (intellectual property, business model, supply chains, etc.), assumes the obligation to comply with its requirements and will pay for this in return. The investor agrees if he sees that this way is easier for him than starting everything from scratch.

Then the investor gets the intellectual property rights, commercial experience, and business reputation. To get started, he usually invests his own money in opening a store, hires employees, and starts managing the business, paying remuneration to the right holder.

For example, a global catering chain and a well-known Ukrainian postal operator work according to this model. Only an entrepreneur can be a party to the agreement, so the investor needs to register as a sole proprietor, or register a legal entity.

What issues an investor should study before concluding a commercial concession agreement in Ukraine:

• the right holder’s requirements to investors, how feasible it is to meet them in real conditions (we have met cases where right holders have set out deliberately unrealistic requirements for financial performance);
• permits required for the business;
• whether the investor is limited to a certain territory, whether the agreement has clauses about non-competition with the investor;
• the agreement with the right holder must be in writing;
• the obligations of the rights holder to advise the investor in the conduct of the business;
• the procedure for the investor to provide and carry out the instructions of the rights holder;
• what the investor must procure independently and what goods and services must be purchased only from the right holder;
• whether the investor is prohibited from conducting related activities after the termination of the agreement (the right holders often limit the further activities of the investors);
• the procedure of interaction between the investor and the rights holder, if the consumer has a claim against the investor regarding the goods supplied by the rights holder;
• the period within which the investor must give notice of early termination of the agreement (according to the law, it must be not less than 6 months, but the agreement may have a longer period).

How we help our Clients:

• Check whether the future partner actually owns the rights that he or she intends to transfer to the investor for use;
• Develop/edit the commercial concession agreement in order to protect the investor’s rights;
• If the right holder refuses to make changes in his template of the agreement, we inform the investor of all the possible risks arising from the wording of the documents offered to him; often this allows the investor to adjust his business plan and investment expectations;
• Provide legal support services to the investor’s business, help with employment issues, permits, tax structuring.

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Passive or management franchise in Ukraine

In the Ukrainian investment environment, a mixed format of cooperation is spreading, where the investor acquires ownership or leases non-negotiable assets (real estate, equipment, cars), obtains permits, invests in repair and decoration of the object in accordance with the right holder’s instructions, and delegates the business to a management company.

By and large, this type of relationship does not have much in common with classic franchising. The actual preparation for starting business is done by the management company, but the property is registered as the property of the investor (except for intellectual property rights). The investor becomes the owner of the business unit, which is managed by the network under his brand.

What problems do investors face?

Management companies claim that all non-current assets are the property of the investor, which guarantees security. In practice, however, the agreements are not clearly drafted, and the investor has no precise understanding of what exactly he owns at a certain point in time. By law, only the ownership of real estate and cars is registered, the ownership of the rest can only be confirmed by primary documents (invoices, delivery-acceptance certificates, etc.). These documents are mainly owned by the management company, not the investor.

Most of the investment is spent on repairing the investor’s business unit, purchasing equipment and products, so the investment has questionable liquidity. If the business does not take off, it will be problematic to quickly resell the property and recover the funds.

The management company manages your business unit, and the investor receives profit from its activities. In this case, the movement of funds is completely dependent on the manager. For example, your retail outlet sells goods that are supplied in bulk to the store by the management company. According to such a scheme, most of the costs of the investor’s business unit is controlled by the manager, and thus the ability to generate profits. That is, the structure of the management company’s network can create a conflict of interest for it.

Management companies are not always ready to allow the investor to make decisions about the operation of the business, so in this context the relationship gravitates toward trust – the investor relies on the professionalism of the manager.

Business units mostly work formally on behalf of the investor, as a sole  proprietor, reflected in agreements with counterparties, permits, and staff employment documents. Therefore, the investor bears the risk of becoming formally liable to suppliers and regulatory agencies if the business runs into difficulties. And while in a classic property management agreement, the manager is also liable for debts under certain conditions, in this mixed contractual format the ability to hold the manager liable is questionable.

How do we reduce risks for investors, our Clients?

• We develop or substantially finalize an agreement, including details of investor rights, the algorithm of interaction and control, and the management company’s authority to dispose of the investor’s property;
• We advise on taxation, proper registration of the investor’s non-current assets, permits required for the business, structuring relations with counterparties;
• We assist not only with the investor’s entrance to the business, but also with the entire lifecycle of the project;
• We represent the investor in relations with partners and controlling bodies.

In general, investing in the formats described in this article can be quite profitable if the investor has conducted a thorough economic and legal analysis of the project. We are ready to undertake the latter.

Please check the cost of investment project support services here. It will depend on the type of investment you choose, the complexity of the project and the amount of services and guarantees you need.

If you want to be sure of where and how you invest in Ukraine, to know in advance the possible risks and profits of the project, don’t hesitate to contact us. We will not only provide an expert analysis, but also help to implement your plan.

Everything about investing in Ukraine here.