About
Franchising
and Leasing
Commercial economics week 5
Describe the significance of franchising
Identify the major advantages and limitations of franchising
Discuss the process for evaluating a franchise opportunity.
Evaluate franchising for the franchisor’s perspective.
Describe the franchisor/franchisee relationship.
Commercial economics week 5
Franchising
Franchising Terms
Terms
Franchising
A marketing system revolving around a two-party
legal agreement, whereby the franchisee conducts
business according to the terms specified by the
franchisor
Franchise contract
The legal agreement between franchisor and
franchisee
Franchise
The privileges conveyed in the franchise contract
…continued
Commercial economics week 5
Franchising
Franchising Terms
Terms
Franchisee
An entrepreneur whose power is limited by a
contractual agreement with a franchisor
Franchisor
The party in the franchise contract that specifies the
methods to be followed and the terms to be met by
the other party
Commercial economics week 5
Types
Types of
of Franchises
Franchises
Product and Trade Name Franchise
Grants the right to use a widely recognized
product or name
Business Format Franchise
Provides an entire marketing system and
ongoing guidance from the franchisor
Piggyback Franchising
The operation of a retail franchise within the
physical facilities of a host store
…continued
Commercial economics week 5
Types
Types of
of Franchises
Franchises
Master Licensee
An independent firm or individual acting as a sales agent
with the responsibility for finding new franchises within a
specified territory
Multiple-Unit Ownership
Holding by a single franchisee of more than one franchise
from the same company
Area Developers
Individuals or firms that obtain the legal right to open
several franchised outlets in a given area
Commercial economics week 5
The
The Pros
Pros and
and Cons
Cons of
of
Franchising
Franchising
Pluses Minuses
Formalized training Franchise fees
Financial assistance Royalties
Proven marketing Restrictions on growth
methods
Less independence in
Managerial assistance operations
Franchisor may be sole
Quicker startup time supplier of some
Overall lower failure supplies
rates Termination/renewal
clauses
Figure 3-2
Commercial economics week 5
The
The Advantages
Advantages of
of
Franchising
Franchising
Proven marketing concept and customer
base
Training
Financial assistance
Operating assistance
Commercial economics week 5
Financial
Financial Assistance
Assistance
Start-up business costs are normally high and
thus by teaming up with a franchise
organization, the individual can increase
her/his chance of receiving financial help.
The franchisor might chose to use liberal
payment schemes to the franchisee in order
to get over the initial financial hurdle.
Commercial economics week 5
Operating
Operating Assistance
Assistance
The franchisor provides a range of operating
services including site selection, bulk
purchasing of equipment, and inventory.
Other areas of assistance include the use of
an established, nation-wide brand
Commercial economics week 5
Pros
Pros and
and Cons
Cons of
of Franching
Franching
Advantages Limitations
– Probability of success – Franchise costs
Proven line of
business
Initial franchise fee
Pre-qualification of Investment costs
franchisee Royalty payments
– Training Advertising costs
Franchisor-
provided – Restrictions on Business
– Financial assistance Operations
Franchisor – Loss of independence
assistance
– Operating benefits
Franchisor-aided
Commercial economics week 5
Limitations
Limitations of
of Franching:
Franching:
Restriction
Restriction of
of Business
Business
Operations
Operations
Restricting of sales territory
Requiring site approval and
imposing requirement on the
outlet’s appearance
Restricting the goods/
services that can be sold
Restricting the resale of
the franchise without their permission
Restricting advertising and hours of operation
Commercial economics week 5
Evaluating
Evaluating Franchise
Franchise
Opportunities
Opportunities
Locating a Franchise Opportunity
Investigating the Potential Franchise
Information sources
Independent, third-party sources
Franchisors themselves
Existing and previous franchisees
Commercial economics week 5
Explanation
Explanation of
of Costs
Costs
Franchise fee Insurance, Licences
First and Last Month’s Rent and Permits
Leasehold Improvements
Training
Equipment
Furniture and Fixtures
Initial Inventory
Signage Working Capital
Royalty
Commercial economics week 5
Global
Global Franchising
Franchising
Opportunities
Opportunities
Historically, many Canadian franchisors have
expanded into the United States.
Canadian franchising enterprises are now
expanding into countries beyond North
America.
Commercial economics week 5
Investigating
Investigating the
the Franchise
Franchise
Candidate
Candidate
Three sources of information:
– independent third party sources
– franchisors
– existing and previous franchisees
Commercial economics week 5
Selling
Selling aa Franchise
Franchise
Why would a businessperson wish to
become a franchisor? Three benefits can be
identified:
1. Reduction of capital
requirements
2. Increase in management
motivation
3. Speed of expansion
…continued
Commercial economics week 5
Selling
Selling aa Franchise
Franchise
Drawbacks associated with franchising from
the franchisor’s perspective.
1. Reduction in control
2. Sharing of profits
3. Increase in operating support
Commercial economics week 5
Franchising
Franchising Frauds
Frauds
The Rented Rolls Royce Syndrome
The Hustle
The Cash-Only Transaction
The Boast
The Big-Money Claim
The Couch Potato’s Dream
Location, Location, Location
The Disclosure Dance
Commercial economics week 5
LEASING
and
Cross border
transactions
Transaction imperatives
Key tax and financial considerations
Income stream
Entry strategy
Financing options
Debt structuring Key tax and financial considerations
Cash repatriation
Exit considerations
Case Study
Business reorganisations
Leasing transactions
Commercial economics week 5
Cross border transaction
imperatives
Business
Cultural Issues
Environment
Business Accounting
Dynamics treatment
Cross Border
Transactions
Legal & regulatory Tax regimes &
framework treaties
Identifying and
delivering synergies
Commercial economics week 5
Key tax and financial
considerations
2 Entry Strategy
1 3
Income flows and Financing
their taxability options
Cross border
transactions
6 4
Exit considerations Debt Structuring
5 Cash repatriation
Commercial economics week 5
Income stream and
1 their taxability
Income streams Principles for evaluation
Dividends Interest, TS and royalty can flow independent
of ownership pattern
TS and royalty would typically flow to an
Capital gains
operating entity, which possess technical
capabilities
Interest
Principal drivers are tax costs associated with
dividend flows and gains on disposal of
Others: royalty / brand fees / technical
services / management services shares
Brand fee would flow to the IPR company
Key elements – arm’s length principle, documentation, overall tax costs and foreign tax credits
Commercial economics week 5
3 Financing options
Parameters Equity Debt (related & third Quasi Debt (Preference
party) stock – mezzanine
instrument )
Term Long Tem Medium to long term Medium to long term
Pay outs Dividend Interest Dividend
Tax rate DDT payable @ 14.025% Withholding tax @ 0 / 10 / DDT would be payable @
15 / 20% 14.025%
Tax credit Not available under most Tax withholding on interest Not available under most
Treaties (check domestic available Treaties (check domestic
laws of home country) laws of home country)
Usage No restrictions Restriction on usage as No restrictions
per ECB guidelines (see
next slide)
No thin capitalisation norms and hence an Indian company can be highly leveraged if it meets
commercial Dividends
requirements
Deductibility and DDT not Interest allowed as Dividends and DDT not
Leveraging deductible
Indian company using overseasdeduction (arm’s length
debt subject to restrictions in deductible;
ECB consider
Guidelines (see next
slide) principle) double dip deduction
Commercial economics week 5
4 Debt structuring
• Internationally recognized sources (international banks, capital markets, multilateral financial
Institutions, equipment suppliers, foreign collaborators)
Lenders • Foreign equity holder if:
ECB up to 5 MUSD – minimum equity of 25%
ECB above 5 MUSD – minimum equity of 25% and debt-equity ratio not exceeding 4:1
• Upto 20 MUSD – Minimum average maturity of 3 years, can have call / put option
Amount/
maturity • Over 20 MUSD to 500 MUSD – Minimum average maturity of 5 years
• ECBs outside the above limits/ maturity period need specific approval
• Investment in real sector (capital goods, new projects, modernization/ expansion of units)
End use • Investment in Infrastructure sector (power ,telecommunication, railways, roads, ports etc)
• Not to be utilized in capital market transactions, real estate, acquisition, working capital,
repayment of Rupee loans
Total cost • ECBs with minimum average maturity of 3-5 yrs: 200 bps above six month LIBOR
of debt • ECBs with minimum average maturity of more than 5 yrs: 350 bps above six month LIBOR
• ECBs upto 200 MUSD can be pre-paid without approval subject to compliance with minimum
Prepayment
average maturity period
MUSD means million United States Dollars
Commercial economics week 5
5 Cash repatriation
Suitability
Dividend distribution Profit making
company
Simplest and most common Ease of repatriation
Capital reduction Cash rich company with
low reserves
Court regulated process, involving repayment of share capital – Loss making company
comparatively complex and time consuming – amount paid to with cash reserves
the extent of accumulated profits of the company would be Maximum amount of
taxable as dividend in India repatriation desired
Share buyback Profit making company
Foreign Co desires to
Repurchase of shares – restricted amount of repatriation – classify the income as
income taxable as capital gains in hands of the shareholder ‘capital gains’ instead of
‘dividend’ – possible
treaty benefits
Broad mechanics of each of the above options have been
discussed in detail in Annexure 1
Commercial economics week 5
6 Exit considerations
Capital gains
No Objection Certificate requirement for setting up new venture – Press note
1 of 2005 (refer Annexure 2 for process)
Shareholder’s agreement and implications thereof –
Right of First Refusal; Tag Along rights; Drag Along rights
Liquidation process – long drawn and Court approval process
Commercial economics week 5
Case Study – acquisition of
business
Target Co
US Corp Mauritian Co Indian Partner
Indian
Global Controls US Corp’s Leading Indian
conglomerate significant strategic holding company (not
engaged in share of the company for part of US Corp
diversified Indian foods Asian group)
businesses market investments Holds majority
Aggressively Leading Has a wholly equity in Target
targeting Asian exporter to owned Indian Co
foods markets Asia subsidiary, F&P,
Has significant Strong track engaged in two
experience in record and businesses -
the foods substantial foods and
business and reserves packaging
commands a F&P has
powerful brand accumulated tax
name losses
Commercial economics week 5
Overview of the structure
Case Study to suggest mechanism to achieve business objectives of Business strategy
US Corp & Indian Partner
US Corp
US Corp Phase I
(conglomerate) • Asian strategy - acquire
control of Target Co
USA 100% • Foods business of F&P to
be consolidated with
Target Co
Mauritian
100%
Co* Phase II
Mauritius • Target Co sells trademark
43% to US Corp
• US Corp licenses
Target Co trademark to Target Co
(Foods) • US Corp receives royalty
India
Indian Partner
57%
Redefining strategy
Focus on core business
*Consider Singapore Foods &
Indian Partner - auto ancillary
jurisdiction Packaging
Auto ancillary Exit non-core business
Commercial economics week 5
Case study - modes of
acquisition
Increase in
stake
Direct Passive Business
increase increase restructuring
Acquisition of Preferential Merger
shares allotment of Demerger
shares Sale of business
Capital reduction undertaking/
of identified sale of assets
shares
Share buyback
The case study however discusses the implications arising under the
merger option, in detail in following slides
Commercial economics week 5
Phase I - Mechanics of
merger
100%
Mauritius 51%
Co 43%
Foods &
Target Co Merger Packaging
Indian 57%
Partner
49%
Present scenario
Issue of shares to Mauritius Co. as consideration of food business Post Merger
Fiscal and regulatory implications of merger
Company Law Implications Tax Implications Other Implications
Special resolution Broadly tax neutral on Valuation of companies
Court approved process satisfying conditions No foreign investment
Dissolution of F&P under Transfer of tax losses and approvals, subject to
Court order without tax benefits of F&P conditions
winding up Tax losses available for No cash outflow for
fresh lease of 8 years Mauritian Co
Stamp duty costs No consideration to Indian
significant Partner on indirect
dilution of its stake
Commercial economics week 5
Phase II – Sale and license
back of trademark
Mechanics
Mauritian
Co
License of trademark –
Target Co transfers
capital gains
Sale of trademark –
its Trademark (‘TM’) 51%
to Mauritian Co. Mauritius
royalty income
Subsequently
India
Mauritian Co
licenses TM back to
Target Co
Target Co
Arm’s length nature of sales and licensing of trademark
May entail service tax and Value Added Tax
Commercial economics week 5
Leasing transactions
Salient features of leasing transactions
Wet lease
Lease of equipment with resources to operate the equipment
Lessor continues to control the operation of the equipment and its maintenance
Example– Lease of an aircraft along with flight crew; lessor responsible for
selection/ hiring of flight crew, operation and maintenance of
aircraft, etc
Dry lease
Lessor merely provides the equipment at a particular
location
Lessee operates the equipment using his own resources
Example – Lease of aircraft without crew
Forms of dry lease:
Operating lease
Finance lease
Commercial economics week 5
Operating Lease vs. Finance
Lease
Operating lease Finance lease
Lessor is the legal and the Lessor is the legal owner
economic owner Lessee is the economic owner
Risks and rewards associated Risks and rewards associated
with the asset not substantially with the asset are substantially
transferred transferred
Risks include losses due to idle capacity, technological obsolescence & changing
economic conditions. Rewards include expectation of profitable operation over economic
life of asset and gain from appreciation in value or realisation of residual value
Source: Accounting Standard 19 issued by the Institute of Chartered Accountants of India
Commercial economics week 5
Taxation of leases – domestic
law
Wet lease Dry lease
Lessor Lessor
• Royalties - Section 9(1)(vi) • Royalties - Section 9(1)(vi)
Or Or
• Section 44BBA - 5% of deemed profits • Section 44BBA – 5% of deemed profits
Lessee Lessee
• Lease rentals allowed as deduction • Resident - Lease rentals would be
• Depreciation allowed to lessor allowed to the lessee
• Depreciation would be allowed to the
lessor
• Section 10(15A) – exemption from tax
withholding extended
May entail service tax and Value Added Tax
Commercial economics week 5
