Star franchisee’s bankruptcy has lessons for franchisors and franchisees

News of the bankruptcy of former Olympic basketballer and high-profile multi-unit franchisee Shane Heal has generally received more attention in the sporting pages than in the business press.

Perhaps part of the reason is the timing of the announcement, on the last business day before Christmas and at a time when business journalists and their readers alike are winding down for the holiday season, while sports journalists are gearing up to cover the cricket and tennis.

While personal bankruptcies are unfortunately on the rise as the fallout from the GFC continues to unfold, Heal’s bankruptcy is significant because of the potential lessons for franchisors and franchisees that it may contain.

Firstly, Heal was a multiple-unit franchisee.

In itself, owning multiple outlets of a franchise is not a bad thing. Multiple unit ownership is one of the factors that continues to grow the franchise sector in Australia as franchisors look to the ranks of its own franchisees for people to open additional outlets, and entrepreneurial franchisees seeking opportunities to grow their businesses into larger operations.

Multiple-unit ownership has many advantages for both franchisors and franchisees, but it sometimes doesn’t work and multi-unit franchisees who were very successful in one or two outlets can find that their profits disappear when they add another one or two outlets thereafter. This hardly occurs in epidemic proportions, but some multi-unit operators can make the jump, and others can’t.

Key factors in determining the success of a franchisee as a multi-unit operator include their level of gearing, their personal commitment to the business, the choice of locations and the proximity of the additional outlets to one another, staffing structures, and management and financial reporting procedures adopted by the franchisee.

Get one or more of these elements wrong, and rather than building an empire, a franchisee could instead be accelerating their financial demise.

Franchisors need to take great care in granting additional outlets to an existing franchisee, and should be applying a higher level of criteria than for new single-unit franchisees. Not only should multiple unit operators have intricate operational knowledge of their business, they must also demonstrate excellent management acumen, have a flair for marketing, excellent HR skills, and significant financial intelligence combined with conservative borrowings.

Franchisors who fail to develop appropriate selection criteria around these attributes, and which fail to implement appropriate monitoring and support mechanisms may find that the short-term gain of an extra few outlets granted to an existing franchisee is not worth the pain of the trainwreck that may follow.

A second lesson to emerge from Heal’s bankruptcy is that not only was he a multiple-unit franchisee, he was also a multiple-brand franchisee. At one point he owned up to 30 outlets concurrently across five different brands including Zarraffa’s Coffee, Subway, Baskin Robbins, Eagle Boys and Noodle Box, and employed around 300 staff.

Multiple-brand ownership is not common among franchisors in Australia, and rarer still among franchisees. One of the reasons is that additional brands can consume a disproportionately large amount of organisational resources that can adversely affect the maintenance and development of the “primary” brand. Another reason is that sometimes additional brands just don’t fit, or come with excessive baggage (think Harvey Norman’s acquisition of Clive Peeters for example).

At either level, multiple-brand ownership is most likely to also involve concepts that have some operational similarity, and service a substantially similar market. All the brands involved in Heal’s case were food businesses, which otherwise compete to degree for a share of the consumer’s palette.

Most franchise agreements have a generic clause that specifically prohibits a franchisee from operating another business of any kind without the franchisor’s prior written consent. The main purpose of such a clause is to keep the franchisee focused on their primary business, and for franchisors to keep tabs on possible conflicts of interest within their network.

Franchisees may occasionally seek to get around this provision by flying under the radar and acquiring other businesses that the franchisor may not find out about until it’s too late. The franchisor then has the choice of invoking the “no other businesses” clause in the agreement and demand that the franchisee divest their external interests, or terminate the franchisee.

Often they turn the other cheek because the ensuing conflict will consume too many resources or be seen as vindictive, and the franchisee gets away with it. This may or may not have been the case with Heal’s multiple brands.

A third lesson is to beware the trophy franchisee.

Heal was virtually a household name in Australia as a four-time Olympian and NBL player. Such a high profile aligned with a franchisor’s brand can enhance the perception of that brand and provide a form of celebrity endorsement.

Heal’s growing profile as a businessman outside the world of basketball would have further enhanced his trophy status as a franchisee, and may have potentially eased his passage through the franchise recruitment process. No matter the profile or background of the franchise candidate, a franchisor should always rigorously apply the selection criteria used for every other franchisee.

A fourth lesson is to keep tabs on the franchisee’s external business interests.

Notwithstanding that a franchisee generally requires a franchisor’s permission to become involved in other businesses, if the franchisor gives consent (explicitly or implicitly), they should also monitor the performance of the additional business to determine if it poses any risk to the franchisee’s outlet or the brand as a whole.

The undoing of Heal and the cause of his bankruptcy appears to be such a business interest.

In a media statement released on December 23, Heal said a 10-year agreement with Allied Brands to develop the Baskin Robbins brand in Brisbane and on the Sunshine Coast once valued at $6 million, was now worthless following Allied’s loss of the rights to operate Baskin Robbins in Australia, and the company’s subsequent insolvency.

Although Allied was placed in administration in late 2010, Heal managed to continue for another year before declaring bankruptcy. During this time, he also maintained basketball coaching and media roles, and acquired the franchise rights to food group Urban Burger where he was preparing to transition from franchisee to franchisor by selling most of his 12 remaining franchise outlets across a variety of brands.

Heal’s bankruptcy provides an inauspicious debut to his career as a franchisor, and potentially throws Urban Burger’s future into doubt.

Ironically, Peter Dinoris of Vincents Chartered Accountants who handled the Allied Brands insolvency has been appointed as Heal’s bankruptcy trustee. While Dinoris insists that the Heal Group of companies is not affected by the bankruptcy, Heal’s own media statement claimed “the Heal Group is working through the situation we are facing and endeavouring to pay back creditors”.

While the principal reason for Heal’s bankruptcy is cited as the worthless agreement with Allied Brands (the external business interest), it compounds the consequences for himself and the other franchise brands unwillingly involved through his status as a trophy franchisee owning multiple outlets across multiple brands.

Bankruptcy is a course a last resort for the financially strapped, with enduring consequences for people’s reputations and creditworthiness, among other things. The timing of Heal’s bankruptcy at Christmas would have been a terrible blow for him and his family.

It also serves as a wake-up call to franchisors and franchisees to heed the four lessons above.

Jason Gehrke is the director of the Franchise Advisory Centre and has been involved in franchising for nearly 20 years at franchisee, franchisor and advisor level.

He advises both potential and existing franchisors and franchisees, and conducts franchise education programs throughout Australia, and publishes Franchise News & Events, a fortnightly email news bulletin on franchising issues and trends.