February 10, 2015

Winter 2015 Franchise Business Network (FBN) Meeting

Winter 2015 IFA FBN Meeting

International Franchising: China and India Presented by: Gary R. Duvall – Dorsey & Whitney LLP Copyright 2015

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AGENDA • 12:30 - 12:40 Gary Duvall: International Franchise Intro • 12:40 - 12:45 Guanxi Zheng – Overview of Franchising in China • 12:45 – 12:50 Sunil Dewan – Overview of Franchising in India • 12:50 - 1:00 Michael Fink – Overview of Starbucks international franchise/licensing program • 1:00 – 1:30 Questions for panel – Including: - Diligence investigation of prospective franchisees – Company-owned versus franchise versus joint venture – Sources of supply – Repatriation of funds 2

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February 10, 2015

Winter 2015 Franchise Business Network (FBN) Meeting

Foreign Owned Units vs Franchising Pros of Franchising • Access to Capital of Franchisee – Allows Faster Expansion • Profit Motive of Franchisee • Shift risk of Localization (Translations, market customization, legal, FCPA, tax, labor, etc.) • More Shifting of Risk – with Master Franchising USED BY MOST US FRANCHISORS

Pros of Company-Owned • More financial return if successful • Costs and risks to Protect Trademark, System, and Trade Secrets from Brand Dilution by non-compliant or mediocre franchisee • Less Control - Exit Risks if Franchisee Fails USED BY SOME LARGER COMPANIES WITH GLOBAL BRANDS AND WITH LARGE COMPANY OPERATIONS IN US 3

Forms of International Franchising • Structure 1: Single-Unit Franchise Franchisor ↓ Franchisee •

Used mostly between proximate countries with similar language, culture and legal systems.

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Franchisor may form a US or foreign subsidiary to offer foreign franchises (for larger franchisors tax nexus strategies become important) 4

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February 10, 2015

Winter 2015 Franchise Business Network (FBN) Meeting

Forms of International Franchising • Structure 2: Area Development Agreement (Area Multi-Unit Franchisee) Franchisor

↓ Area Developer [One Area Franchise Agreement] ↓ ↓ ↓ ↓ [Many Unit Franchise Agreements with same Developer]

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Forms of International Franchising - Master

• Structure 3: Area Representatives Franchisor ↓

↓↓↓↓↓↓

Area Rep | Many Unit Franchisees Area Rep - - > [Recruits and Services for Unit Franchisees – but does not sign the unit franchise agreements.]

↓ = Agreement

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February 10, 2015

Winter 2015 Franchise Business Network (FBN) Meeting

Forms of International Franchising - Master

• Structure 4: Subfranchising

Franchisor ↓

Master Franchisee (Subfranchisor)

↓ ↓ ↓ ↓ ↓ Many Unit Franchisees ↓ = Agreement

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Forms of International Franchising-Hybrids

• Structure 5: Joint Venture •

Franchisor ↓

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Forms a joint venture with Master Franchisee or Developer (sometimes 50/50) ↓ Master Franchisee (Subfranchisor) ↓ ↓ ↓ ↓ ↓ Many Unit Franchisees ↓ = Agreement 8

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February 10, 2015

Winter 2015 Franchise Business Network (FBN) Meeting

Forms of International Franchising-Hybrids

• Hybrid Structures: •

Test Period Agreements (Development rights continue or end based on specific criteria after initial 2-5 years.)

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Hybrid - Development and Master Franchise (Master must open some company units, often in a smaller territory, and as a pre-condition for subfranchising)

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Hybrid - Combined Trademark License and Master Franchise (Licensee/franchisee is free to develop a localized system, and licensor/franchisor provides little support.) Used primarily: 1) licensor is a supplier not a franchisor in its home country; or 2) target country is small, distant, and different from home country. 9

China Franchise Law •

China has disclosure, relationship and registration

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Everything must be translated and filed with MOFCOM, including disclosure, contracts, agreements, and underlying entity documents.

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Franchisor has to prove that it has operated at least two company-owned units for at least one year. A master franchisor (subfranchisor) in China has the same requirement.

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Franchisor’s Trademark must be registered, and a separate trademark license agreement registered with the trademark office

Franchise Legal Compliance Costs in China are possibly the highest in the world. 10

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February 10, 2015

Winter 2015 Franchise Business Network (FBN) Meeting

India Franchise Law •

India does not have specific franchise laws

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Franchisor’s trademark must be registered, and a separate trademark license agreement must be registered with India trademark office; India is a member of international Paris Convention

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Enforcement of post termination non-compete clauses is uncertain, but a possible work-around is to enforce trade secret clauses

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Repatriation of royalties is subject to government review and approval (foreign exchange, federal reserve bank, tax clearance), and formerly royalties were limited to 5%.

Franchise Legal Compliance Costs in India are not the issue; the issue is political and governmental risks.

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Other Issues-International Franchisors •

File Trademarks: early, when franchising is just a “twinkle in the eye”.

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Protect Trade Secrets: by technological means and by contract; reversion of know-how to franchisor or franchisees under technology transfer laws

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Financial Considerations: repatriation of funds under foreign laws e.g. offshore funds vs. repatriation, withholding tax on payments by franchisees (gross up or allocation clauses), currency risk, exchange controls, caps on foreign payments, and central bank filings

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Cross-border supply considerations (e.g. local sourcing versus global suppliers, customs duties, etc.) 12

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February 10, 2015

Winter 2015 Franchise Business Network (FBN) Meeting

Getting Started: Locating Franchisees • Internet Inquiries – Portals – They Find You • Trade Shows – About 50 Franchise Associations (US IFA) and about 40 Trade Shows (US – IFE) • U.S. Government and State Export Assistance Programs; e.g .US Embassies and Export Assistance Centers abroad; US Commercial Service of US Commerce Department partner (franchisee) search programs (Gold Key) • Co-sponsored IFA and US Government trade missions – pre-screened applicants, travel to 2-3 countries in each mission. • Contacts with Advisors: Lawyers, bankers, accountants, consultants, etc.

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Getting Started: First Steps 1. Confidentiality Agreement 2. Application to Register Trademark (start with composite design mark in one class) 3. Term Sheet/MOU – general terms 4. Diligence on Candidate – Including Patriot Act research; consultants and US Gov have services to screen and do credit and background checks 5. Travel – Discovery Visit 6. Internal Approval – begin negotiation detailed terms, e.g. how often franchisor visits country 7. Draft a binding LOI with a non-refundable deposit 8. Draft master franchise or other agreement, begin other legal compliance; US counsel retains local counsel as needed. 14

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February 10, 2015

Winter 2015 Franchise Business Network (FBN) Meeting

Thank You!

Gary R. Duvall Dorsey & Whitney LLP Seattle, Washington 206.903.8700 [email protected]

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