In our previous discussion we explored the importance of establishing a foundation to any equity sharing relationship. In this follow-up we look at specific provisions of the shareholders’ agreement and other methods to avoid and resolve disputes.
Capital Contribution. Clearly state how much each shareholder has contributed, whether the capital is applied as equity or shareholders’ loan and terms of repayment, if any.
Also, determine how to apply and repay future shareholders’ loans, and any arrangements when raising capital in the future from shareholders and third parties. In some instances shareholders’ will be required to contribute monies, security, or sureties.
Related: Understanding Shareholder Agreements
Minority and Majority Shareholder Perspectives
Minority shareholders look for protection in quorums to start meetings, vote at meetings and pass resolutions, and the right to appoint directors on the board.
This ensures complete and autonomous representation of shareholders and reduces the risk of ambushing or bullying tactics by majority shareholders. Minority shareholders also look for protection on disposal of shares in the Tag Along principle – if a majority is selling, the minority has the right to join the deal.
Similarly, majority shareholders look for protection in adequate board representations and quorums. Critical to majority shareholders is pro rata participation of all shareholders and that the majority is not required to carry the burden of financial or administrative support or pro rata dilution if the business issues new shares.
Similar to the minority, the majority is protected during disposal of shares in the Drag Along principle — if a third party wishes to buy all the shares of the business and the majority wishes to sell, the minority is forced to sell.
Disposal of Shares
Disposal of shares includes sale to a third party, disposal on death or incapacity, or retirement as an exit strategy. Shareholders often dread the introduction of heirs and beneficiaries to a deceased estate for multiple reasons, including the lack of ability to strategically influence the business.
Mechanisms in managing disposal of shares for the Shareholders’ Agreement may include pre-emptive rights or first option rights to remaining shareholders for voluntary and involuntary sale; or introducing a succession plan for retirement; or establishing a call/put option to the business on retirement dates.
Resolve Shareholder Disputes
Shareholders’ Agreement. The Companies Act and Memorandum of Incorporation adequately cover the basic terms of engagement including powers, duties and related limitations. It is not a requirement of law to execute a Shareholders’ Agreement, however, it is recommended.
Negotiation and Mediation
The first step in resolving a dispute is for parties to commit to avoiding approaching the courts. To this end, the Shareholders’ Agreement should clearly state that all parties will negotiate, and if required appoint an appropriate independent third party, such as an expert in the field of the dispute, to mediate the negotiation.
The Companies Tribunal
This tribunal is established in terms of the Companies Act and is a voluntary resolution of disputes as an alternate to formal arbitration or litigation. Its mandates adjudicate any matter regulated by the Companies Act.
If the negotiation and mediation is unsuccessful the parties can approach an arbitration body, such as the Arbitration Foundation of South Africa, or submit a complaint to the Companies and Intellectual Property Commission.
The point of arbitration is to offer an alternate to resolving disputes in court. The rules and costs of this route must be considered.
The Shareholders’ Agreement must allow for any party to approach the courts if alternate resolution is unsuccessful or if a matter is considered pressing, such as an application for an urgent interdict.
As with arbitration, shareholders must consider the cost implications of this remedy.
A shareholder cannot be dismissed nor resign voluntarily or involuntarily. The only way a shareholder may exit the business is if she sells, donates or bequeaths her shares to a third party, the remaining shareholders or the company; alternatively if the company liquidates.
It is critical that two important aspects of preventing or resolving shareholders’ disputes are implemented at the outset of a start-up business: Ensure that this is the right match for you and your business, and be absolutely certain about when and how to exit if the arrangement doesn’t work.
Types Of Funding Available For Franchisees
If you’re interested in investing in a franchise, there are a number of funding routes available to you.
In South Africa, a franchise is considered a separate, specialised field of business and from a financing perspective is viewed differently to an existing business. It’s typically easier to get funding for a franchise as franchises have a proven product and they vet potential franchisees and offer support to new business owners. This support can include extensive training on running the franchise, branding and marketing, operational policies and procedures and a highly-tuned supplier network.
The reputation of the franchise will, to a large extent, dictate which finance options you choose and how easy it will be to raise the required funds.
It’s important to understand the cost of purchasing the business and the expected operating costs to work out how much finance you’ll need until the business starts to generate profits. Be clear about the upfront costs, including access to the brand, the market structure, start-up support and the set-up fee, which usually includes construction, equipment, stock and other necessary resources.
Consider the operating costs, which must include management service fees and franchise marketing and advertising levies. The franchisor will advise you on the time it should take for the franchise to start generating profits. Upfront costs plus operating costs are the total amount of finance required to purchase, set up and run the franchise.
What’s available for prospective franchisees?
Many of the large franchisors have their own funding mechanisms. These can range from their own established finance arm to funding assistance through partnerships with external lenders. Franchisors seldom fund 100% of the purchase costs; the amount of funding varies according to the size and reputation of the franchise and usually ranges from 25% to 75% of the costs.
Once a franchisor approves you as a franchisee, your chances of being approved for funding are significantly stronger. Some franchisors go a step further and suggest a business partnership with another potential franchisee who has good financial resources but less experience. Pairing experience with finance can be a useful option, but needs to be explored properly as it is a long-term partnership that must work for both parties.
Tandem Funding and Specialised Franchise Funders
South Africa’s B-BBEE legislation has led to a new option for franchise funding. It’s a particularly innovative way of quickly upskilling inexperienced potential franchisees. The franchisor funds the new franchise and retains ownership of the majority of shares in the business.
The franchisee initially purchases a small number of shares and is then mentored by the franchisor to set up and run the franchise. Profits are used to buy more shares until the franchisee has purchased all the franchise’s shares.
Specialist franchise funders are also a useful option. They typically consider a wider variety of franchises than banks and have in-depth knowledge of the industry. However, like other funders, their primary concern is to be sure that the loan will be repaid within the required period.
Franchise Funding from Banks
All of the large banks have specialised franchise funding departments. Their approval rate for funding franchises is generally higher than for independent businesses.
Banks will expect you to provide a sizable contribution toward the purchase of the franchise and funding is dependent on proof that the business will be able to repay the loan.
Other factors they consider are the location of the business and its proximity to competitors and catchment markets, your level of business experience, your credit record and the amount and type of support offered by the franchisor. The higher the level of support, the less the risk to the funder of the business under-performing.
If the franchisor is willing to enter into a joint venture with you to partially fund the purchase, the bank will consider this positively as it means the franchisor has a vested interest in helping you to succeed.
Government Franchise Funding
All of the government funding agencies offer franchise funding primarily to encourage black entrepreneurs to enter into the franchise business. For example, the National Empowerment Fund considers funding based on a minimum of 50,1% black shareholding, provided that the black shareholders are actively involved in managing the business.
They prefer to fund well-established franchises, fund up to R10 million and expect to exit within seven years, so you’ll need detailed projections to show that the loan can be repaid within that period. Ithala Bank considers funding for KZN-based approved franchisees who do not have collateral.
What funders expect from you
Lenders expect you to provide detailed information that will enable them to assess the risks of lending to the franchise. This means they require a detailed business plan, comprehensive and well- substantiated financial projections and full details of the franchise, its agreement terms and the levels of support they will provide. They will also need details of start-up costs; for example, construction, set-up costs, equipment and other resources required to establish the franchise.
Franchise lenders expect you to have concluded discussions with the franchisor and want to know that you have been approved. This pre-approval means that there is less risk to them. You’ll also be expected to provide feasibility studies from the franchisor.
The purchase of a franchise requires an injection of your own cash and if you are borrowing money, you’ll probably need to provide collateral. You’ll need a statement of personal assets and liabilities for each of the directors, a good credit record and detailed CVs of the owners to show the required business experience.
The more well-known the franchise, the higher the price, so do your homework before applying for finance. Understand the full cost of starting and running the business to make sure you aren’t in for future surprises. In particular, work out your current liquidity status.
Keep a small contingency fund available for unexpected expenses, so don’t invest all available capital in the venture.
Shop around. Compare finance institutions’ offerings to make sure you get the best deal. In the case of less expensive franchises, consider working with a couple of lenders; for example, an asset funder to fund equipment needs and a franchise funder for the start-up and working capital costs.
Factors To Consider Before Signing Up As A Franchisee
Franchising is a brilliant way to get into business with not many entrepreneurial skills as it comes with a roadmap to follow for success.
You’ve been considering entrepreneurship for a while, and now that you’ve finally raised some money and been approved for a loan, you’re ready to quit your 9-5 job to run your own business. You may even already have your eye on a particular franchise, but while franchising is considered an easier and more low risk way to get into business, are you suited to being a franchisee?
“The question is not ‘is franchising right for you’, but rather, are you right for franchising? Because if you don’t have the right attitude and skill set, it can be a very expensive mistake,” says small business expert and author Steve Strauss.
Franchising may seem like an easy way into entrepreneurship, but along with an established name and proven systems, come rules, regulations and little room for creativity. If you’re not ready to become a franchisee, but want to go into business for yourself, you may find yourself struggling to operate within the system’s blueprint.
Ask yourself these three questions before proceeding with the process of franchising:
1. Will you be able to follow the directions of the franchisor?
You’re buying into an existing and proven concept so it’s safe to assume that the franchisor knows best, and so you have to be open to learning and following guidelines for business success. If, for example, you have experience in advertising and think you have an improved technique of marketing the franchise, you may want to change the advertising material provided by the franchisor – don’t.
“Being a franchisee means following the directions of the franchisor, even when you think you know a better way,” advise experts from strategic and tactical advisory firm MSA Worldwide.
“In addition to initial training, you need to be prepared to accept coaching and advice from the franchisor on how you operate or market your location.”
2. Do you have the need to experiment?
Lou Groen may have had success in launching a new menu item that McDonald’s approved of in 1962, but not all franchisees are that lucky. Stick to the plan and limit deviations to the menu or anything that involves the customer experience.
If the franchisor’s concept doesn’t involve deliveries, offering them to your customers may cause issues for others within the franchise system. “If it’s not part of the franchisor’s concept, you’re deviating from the concept and therefore, no longer running your store as a franchise,” according to MSA. Franchising arguably limits innovation opportunities, so if you’re prone to implementing creative ideas and evolving business offerings based on said ideas, rather start your own independent business.
3. Are you a team player?
These first two questions you address should already lead to the realisation that everything you do affects everyone in the franchise chain. One bad experience at your establishment and suddenly, all the stores are affected by bad press or unsavoury social media attention.
“Other franchisees are relying upon you to offer to the consumer a consistent level of service, product quality, and brand message. You are going to have to work with others in the system in making decisions,” advise experts.
Remember that as part of a chain of other business owners, you may have to accept that majority rules when it comes to decisions where franchises do have a say.
3 Ways You Can Innovate And Improve As A Franchisee
Although your role as a franchisee isn’t really to innovate, there’s room for creativity if you go about it the right way.
When you signed on the dotted line after reading and agreeing with the franchise agreement, you knew that you were buying into a proven system where everything has already been thought out for you, and all you have to do is follow the formula for success.
But you’re a franchisee longing to put your own imprint on your business, and it may be frustrating to feel boxed in by a formula, while you’re bursting with new ideas.
“Franchising, by its nature, discourages innovation on the part of franchisees, who are required by their franchisors to follow very specific policies and procedures on exactly what they will sell, how they will make or deliver it,” notes Randy Myers, contributing editor for CFO and Corporate Board Member magazines.
This doesn’t mean your ideas will never see the light of day though. But before you approach your franchisor with your brilliant insight, consider the following steps that may well lead you down an innovative path:
1. Get the basics right first
Franchisors know that customers like consistency as it makes them comfortable and trust every location of their franchise they choose to visit. But, even the strictest franchisors get hungry for new ideas. It’s the timing that’s vital for your idea to even be considered.
“Most good systems don’t want new franchisees to even think about innovations until they learn the existing system inside out and prove that they can execute it like a star,” said Jeff Elgin, CEO of FranChoice, a network of franchise referral consultants. “At that point, they have become successful, their base is secure, and they have earned the right to consider innovations.”
It’s wise to ensure you’ve learned your franchisor’s existing business model before you suggest any improvements.
2. Do your homework
So, you’re doing well and you’re sure your idea will be welcomed as a crucial innovation to the franchise system – but research your proposal, suggests Kim Stevens, VP of Regional Development and Director of Franchise Awarding at Woodhouse Day Spas. “Especially if you’re suggesting something that would impact all franchisees, create a business plan before approaching your franchisor,’ she says.
It’s also good to have another look at the franchisor’s policy for accepting new ideas to ensure you’re prepared for tough questions before you propose your idea.
3. Speak to the right people
Elgin recommends you first identify the person at the franchisor’s head office who’s responsible for receiving new ideas. “Many of the ideas a franchisee comes up with will already have been proposed by another franchisee,” notes Elgin.
To avoid wasting your time, no matter how great you think the idea is, present it as early as possible before spending anything developing the idea.
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