It's a wrap – what lessons can franchisors learn from the demise of Wrapchic?

Wrapchic, the Asian fusion QSR concept, fell into administration earlier this year after shareholders refused to lend further funds as it continued to make losses.

Wrapchic is one of a number of recent casualties in the food and beverage sector in the UK, but unlike some of the more high profile casual dining brands which have suffered a similar fate, Wrapchic was almost entirely franchised and operating in the generally more resilient "QSR" segment of the sector. So why did it fail and what lessons can franchisors learn from this?

Why did Wrapchic fail?

Whilst there may have been innate issues with the concept and wider macro-economic factors which contributed to its demised, a recent statement by the administrators revealed that two distinct issues:

1.             Wrapchic held a number of leases and sub-let to franchisees. A number of franchisees defaulted and ceased to trade, meaning that Wrapchic was exposed to the full ongoing liability under the leases for poorly selected sites.

2.             Wrapchic operated a central production unit, which generated high overhead costs compared with the margins the company was making.

What are the lessons for franchisors?

1. Risk. One of the key benefits of franchising is that the growth of the network is funded by the franchisee's investment in human and capital resources, and franchisees consequently take the risk associated with that. By entering into headleases with landlords and subleasing to franchisees, Wrapchic was shifting a significant risk back onto itself.
2. Real Estate Strategy. It is not uncommon for franchisors to take on headleases, particularly where a landlord may require a stronger covenant or the franchisor wishes to exert more control, but in our experience franchisors should adopt a flexible approach wherever possible to allow it to hedge its risks more effectively. For example:

(a)            Only take headleases for key sites where a franchisor is confident that it can step in and operate or sell on the lease in the event that the franchisee is not successful. And keep the lease terms as flexible as possible – it may be worth paying a little more in rent to secure regular break options.

(b)            Allow sub-franchisees to enter into leases directly with landlords, but consider putting in place a real estate procurement service (in-house or outsourced to property agents) which ensures that there is a robust site selection criteria and systemised legal process.

(c)            As a halfway way house between taking control of the lease and not having any involvement in the landlord-tenant relationship, franchisor could consider agreeing a "step-in deed" with landlords prior to the franchisee entering into the lease. This would give the franchisor the option (but not the obligation) to take over the site on termination.

(d)            Consider entering into a joint tenancy with the franchisee. The key benefit here being that it overcomes the strength of covenant issue and it should be simpler to swap franchisees into the relationship than a headlease/underlease arrangement. The main disadvantage being that the franchisor still has a direct liability to the landlord which the franchises will look to pass onto the franchisee (usually through a separate deed of agreement and power of attorney between the franchisee and franchisor).

3.             Supply Chain. Depending on the nature of the business the level of its maturity, offering a central production service may not be a suitable strategy. Franchisors should look at their supply chain in terms of "core" and "non-core" products/equipment and then consider whether they or a nominated third party supplier are best placed to provide core/product and equipment. Franchise agreements are long term contracts and it is therefore advisable to ensure that they contain in-built flexibility to ensure that a franchisor can exert more or less direct control over the supply chain, depending on the lifecycle of the business. It would appear in the case of Wrapchic that it was attempting to operating a supply chain model which did not fit with the relatively small size of the network.

4.             Walk before you run. This is easy to say with the benefit of hindsight, but the initial fast growth of the Wraphic in the UK and internationally suggests that concept was not sufficiently developed before it was franchised and/or the business was overstretched or distracted by international expansion when its focus should have been in its domestic market.

5.             Play the long game. Businesses can be too eager to embrace the franchise model or respond to a flattering enquiry from overseas, and both reactions are entirely understandable. However, in our experience a common theme amongst successful franchisors is that they invest in expert (legal and non-legal) advice early on, develop a clear strategy underpinned by robust legal agreements and crucially keep investing in their own system and regularly reviewing their strategy and associated agreements. This all comes with a price tag, but as the saying goes, "penny wise, pound foolish".