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Franchising in Germany

Heiko Stumpf

Manager Investor Support Service

Germany Trade & Invest

Winter/Spring 2011

www.gtai.com 2Franchising in GermanyFebruary 2, 2011

I. About Germany Trade & Invest

II. Introduction to Franchising

III. How to start a Franchise System in Germany

IV. The Franchise Contract

V. Links and Contacts

www.gtai.com

The Agency

3Franchising in GermanyFebruary 2, 2011

Germany Trade & Invest is the foreign trade and inward investment promotion agency of

the Federal Republic of Germany.

The Federal Ministry of Economics and Technology is our shareholder. The agency is also

funded by the Federal Ministry of Transport, Building and Urban Affairs.

Germany Trade & Invest…

supports export-oriented companies based in Germany with comprehensive foreign market information.

promotes Germany abroad as a high-performance economic and technology location in order to attract investors who create/secure jobs in Germany.

consults potential foreign investors in terms of their settlement plans and realizes the required project management support in Germany.

An additional special focal point of activity lies in promoting the economic development of

the new federal states including Berlin.

www.gtai.com 4Franchising in Germany

ChicagoNew YorkSan FranciscoToronto Washington

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Athens BrusselsLondonMadridMilan ParisStockholm

DubaiIstanbul

JohannesburgCairoNairobiTunis

BelgradeBudapest Bucharest KievMoscowPragueRiga Warsaw Zagreb

BangkokBeijing HanoiHong KongJakartaKuala LumpurMumbaiNew Delhi SeoulShanghaiTaipehTokyo

Sydney

Tel Aviv

BerlinBonn

The Agency

Two headquarters in Germany - 46 locations worldwide.

February 2, 2011

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Germany Trade & Invest concentrates its market competencies within a

range of industries

Picture Credit: Helmholtz Centre Berlin for Materials and Energy; BMVBS/Amin Akhtar; Copyright Dreadlock/Fotolia; BMU/Rupert Oberhäuser, BSW/Paul Langrock;

BMU/Brigitte Hiss; Bundesverband Windenergie e.V; Copyright BMU / Bernd Müller

Our Teams

February 2, 2011 5Franchising in Germany

Renewable Energies & Resources

- Photovoltaics

- Energy Efficiency

- Renewable Resources and Bioenergy

- Energy Storage and Fuel Cells

- Solar Thermal Energy

- Geothermal Energy

- Wind Energy

- Waste to Energy, Recycling and SustainableWater Resource Management

Chemicals & Healthcare

- Chemical Industry and Polymers

- Chemicals-Related Process Industry

- New Materials/ Composite Materials

- Red Biotech

- Medical Devices Industry

- Pharmaceuticals Industry

Service Industries

- Consumer Goods/Retail/Franchising

- Food and Beverages

- Information and Communications Technology

- Business Services

- Transportation and Logistics

- Tourism

Mechanical & Electronic Technologies

- Electronics and Microtechnology

- Machinery and Equipment

- Transportation and Technologies

- Applied Sciences and Technology Transfer

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Project Management Assistance

Location Consulting/Site Evaluation

Project partneridentificationand contact

Business opportunityanalysis and market

research

Market entrystrategysupport

Joint project management with regional development

agency

Coordination and support of

negotiations with local authorities

Final sitedecisionsupport

Site preselection

Identification of project-specific location factors

Cost factoranalysis

Site visitorganization

Organization ofmeetings withlegal advisorsand financial

partners

Identification of relevant tax and legal issues

Project-relatedfinancing and

incentivesconsultancy

Administrative affairs support

Accompanyingincentives

application andestablishment

formalities

Decision & InvestmentEvaluationStrategy

Support Services

Complete your project management needs from our range of investment

and one-stop project consultancy services

Our Investment Project Consultancy Services








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…a system of marketing goods and/or services and/or technology, whichis based upon a close and ongoing collaboration between legally andfinancially separate and independent undertakings, the Franchisor and itsindividual Franchisees, whereby the Franchisor grants its individualFranchisee the right, and imposes the obligation, to conduct a business inaccordance with the Franchisor's concept.

The right entitles and compels the individual Franchisee, in exchange fora direct or indirect financial consideration, to use the Franchisor's tradename, and/or trade mark and /or service mark, know-how, business andtechnical methods, procedural system, and other industrial and /orintellectual property rights, supported by continuing provision ofcommercial and technical assistance, within the framework and for theterm of a written franchise agreement, concluded between parties for

this purpose.

According to the European Franchise Federation franchising is defined as:

Definition


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The franchisor and franchisee play different, but complementary roles:

Franchisor and Franchisee


Franchisor

• Grants right of use of trademarks and „Know-how“ (non-patented practical information, resulting from experience and testing, which is secret, substantial and identified)

• Consecutive supply with goods

• Other support (i.e. training) and assistance

• Develops the business’s concept to ensure credibility and quality of the brand (i.e. through advertising)

Franchisee

• Payment of entry fee and royalty and/or a combination of fees and adherence to the franchisors guidelines, especially to the common identity

• Acceptance of supplied goods

• Participation in the support activities and development of the business

• Owns his franchised business and is legally and financially independent of the franchisor

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3741

4744

48

70

0

10

20

30

40

50

60

70

80

2006 2007 2008 2009 2010 2015

The German Franchise-Industry is growing significantly

Sources: German Franchise Association, 2011; Deutsche Bank Research, 2009

The German Franchise Industry - Overview


Sales of the German franchise industry(in EUR billion)

Within the last ten years, the sector managed to double its sales from EUR 22 billion to EUR 48 billion in 2010.

Sales are expected to keep up strong growth, reaching an estimated EUR 70 billion by 2015.

Distribution of franchising by sector(in %, 2009)

The service sector is dominating the German Franchise-industry with a market share of more than 40.0%, followed by retail with almost 23.0%.

The service sector is an important growth driver; however, other sectors mainly in restaurant and catering have expanded considerably.

41.2%

22.5%

13.5%

4.1%

5.4%

7.3%

6.0%

Services

Retail

Hotels/Gastronomy

Tourism/Leisure

Fitness/Health

Handcraft

Others

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Franchising in Germany exhibits a constant upward trend in number of

franchisors and franchisees as well as employees

Source: German Franchise Association, 2011

The German Franchise Industry - Overview


Franchisors Franchisees Employees in Franchising

1000 franchise systems operate in the German market (+4%).

About 64,000 franchisees take advantage of the growing market.

With 470,000 employees, franchising is an important business sector in Germany.

In 2010, on average each franchise system employed 470 people.

(in 1,000) (in 1,000)

870

900910

950960

1000

800

850

900

950

1000

1050

2005 2006 2007 2008 2009 2010

4851

5557

6164

0

10

20

30

40

50

60

70

2005 2006 2007 2008 2009 2010

421

429

441

450

459

470

390

400

410

420

430

440

450

460

470

480

2005 2006 2007 2008 2009 2010

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There are about 1000 franchising systems active in the German market

Franchise Systems


1. Development of an entirely new franchise system and finding

local franchisees to buy the developed “business kit”.

2. Master-Franchising: adoption of an established franchise system

to the German market.

To achieve a high reputation the franchise system should fulfill certain minimum requirements set by independent organizations or associations. Especially the form of the franchise contract and the information policy of the franchisor are important criteria. Compliance with those criteria can be proven by:

Becoming a member of the German Franchise Association (Deutscher Franchise-Verband – DFV) which already has about 285 members.

Certifying the system with the Franchisee Association Germany (Deutscher Franchise-Nehmer Verband – DFNV).

Generally two types of market entry exist:

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Master franchising is an effective way to adapt an international system to a

new market because the knowledge of an experienced national partner is

used

Master Franchising


The master franchisee obtains a license from the franchisor that allows him to establish and run an elsewhere existing franchise system in a country or region in his own name and for his account. Master

franchisee

Franchisee Franchisee Franchisee

Franchisor

The master franchisee accustoms the franchise system to the national market and runs at least one pilot business before establishing the respective system.

The master franchisee assumes the role of the franchisor for the respective territory.

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When establishing a franchise system the following steps should be

taken:

How to start a Franchise System in Germany


Strate-gy

• Design of the system

• Defining the target group

Plan-ning

• Business Plan and calculation base

• Test run

• Financing and Incentives

System setup

• Pilot operation and description of Know-how

• Development of franchise manual and training concept

• Drafting of franchise contract

Expan-sion

• Finding of franchisees

• Master-franchising

Imple-menta-

tion

• Quality management

• Functional franchise management (consecutive trainings and development)

• Central buying structure

The system must be attractive, appear competent and safe

The results of the test run determines the further development

Pilot operations with several franchisees should be carried out to identify remaining weaknesses

Finding of the right franchisees is crucial for the success of the system

Ap

pro

x. 2

-4 y

ea

rs

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A successful franchisor has to maintain a strong and close

relationship to their franchisee, e.g. offer bulk

discounts, sustain a knowledge gap.

Experienced franchisors are examples for new franchisees

and support partners in all aspects of the business.

A stable, preferable, growing market and a long-term commitment is required to ensure

the success of a franchise system.

The competitive strength of a franchise system is, amongst

others, defined by the product/service, market share, image, branding.

Continual target-performance

comparison, quality control and training

measures for franchisees.

Franchisor’s requirement profile determines the availability of potential partners, e.g. industry experts or outsiders.

Success elements have to be defined and stand-ardized to be easily transferred to new franchisees.

Franchise systems require sufficient

funding to finance the start-up and

expansion phase.

Factors determining the success of a franchise system include:



Success factors of

a franchise system

Market potential

Competitive strength

Controlling

Partner potential

Transfer-ability

Know-how

Capital base

Strong relationship

Success Factors

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Adequate franchisees are the most important success factors of the

franchise system besides the product/service itself

Acquisition of Franchisees (I)


Qualifications: customer orientated, leadership skills, willingness to integrate into the system and undergo further training, teamwork, resilience

Relevant experiences in the filed of franchising

Availability of equity: enough financial funds to cover the first months should be available

Education: knowledge in business administration, especially sales and distribution

Key qualifications to look out for in franchisees include:

Types of franchisees

Start-ups

Existing operators within

the segment (conversion)

Existing operators from other segments (diversification)

Restructuring of an existing outlet

system (reorganization)

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How to find a franchise partner in Germany

Acquisition of Franchisees (II)


Contract negotiation

First contact/ statement of

interest

Bilateral exchange of information

Interview/ personal meeting

Detailed self-disclosure

If applicable, signing of MoU

or LoI

Inhouse seminar

Signing of franchise contract

Identification of partners

Advertisements Public Relations Direct marketingTrade fairs, business

start-up fairs, chambers of commerce

Business directories, associations

Definition of franchise concept

Strengths over individual foundation Advantages over competitors Market position and prospects

www.gtai.com

The franchisor has to conduct a trial with at least one franchise project before

concluding the first franchise contract.

The franchisor has to train the franchisee in the beginning to ensure successful

market entry.

The franchisor must hand a copy of the code of ethics to the franchisee before

concluding the franchise contract.

All important information and documents must be handed to the franchisee in

writing.

The franchise contract must be handed to the franchisee immediately after

signing.

The German Franchise Association provides a code of ethics regarding the

fair treatment of franchisees and franchisors. The most important

provisions are:

Code of Ethics








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The franchise contract is not explicitly regulated by law. It can be

categorized as a mixed contract

Legal Nature of the Franchise Contract


The franchise contract is closely related to the distribution contract.

In distribution law the following contracts can be distinguished from the lowest to the highest degree of vertical integration.

Supply Contract

Specialty Retailer

Authorized Dealer

Commission Agent

Commercial Agent

Franchise Contract

Franchise contract

Commercial Law

Civil Law (i.e. Sales, Rent, Loan, Consumer Protection)

License and Intellectual Property

Law

Company Law

Employment and Social Insurance

Law

Competition and

Antitrust Law

Case Law

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The duties of the franchisor depend on the structure of the system. Generally the following duties are inherent in most systems:

The duties of the franchisor depend on the structure of the system.

Generally the following duties are inherent in most systems:

Duties of the Franchisor


Duty of the Franchisor Scope of the duty

Transferring right of use of Know-how and intellectual property

The scope can be individually agreed upon. This aspect should be described in much detail in the franchise contract.

Disclosure of information Usually done in the guidelines, the manual and during regular trainings - everything that is important for running the franchised business must be disclosed to the franchisee.

Incorporation in the system

Offering continuous consulting and support to the franchisee even before opening the business.

Facilitation of the business

Especially market observation and development of new products and services in order to keep the system competitive.

Guaranteeing non-competition

The franchisor should provide a geographic sphere of non-competition to protect the franchisee from ruining competition.

Supply products The franchisor has to supply the franchisee with the agreed amount of products.

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The franchisee has to fulfill the obligations of the franchise contract. His

foremost duties include:

Duties of the Franchisee


Duty of the Franchisee Scope of the duty

Application of the system The franchisee must adhere to the guidelines set out by the franchisor in the manual and participate in trainings.

Business management The franchisee has to set up and run his franchised business for the duration of the franchise contract.

Payment of fees The franchisee has to pay the fees agreed upon.

Duty to disclose

information

All issues relevant to the franchisor have to be reported to

him.

Interest protection Activities undertaken by the franchisee must consider the interests of the franchisor.

Merchandizing The franchisee has to continuously facilitate the sales of the products. Contractually agreements can include: minimum order quantity, obligation to accept products, obligation to present the products in a specific way

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The franchisor has to disclose the calculation base of his franchise system

to enable the franchisee to estimate the profit margin. This includes:

Pre-contractual Duty to Disclose Information


• Information about the profitability of the franchise system

• Information about already existing franchise businesses

• Clear and comprehensive description of the marketing concept and Know-how

• Amount of capital needed by the franchisee and expected amount of work input

• Expected profits

• Possible dangers

• Kick-backs the franchise system is granted for the turnover of the franchisees

(However, those benefits must not be shared with the franchisees.)

The information provided must be true, accurate and not misleading. It should be based on:

If the duty of disclosure is not complied with the franchisor may be held liable for damages. A protocol about the provided information should be drawn up.

Extensive market analysis data

Data obtained during trials in more than one establishment

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Franchise contracts usually consist of general elements and industry-

specific provisions. The following questions should be addressed:

Content of the Franchise Contract


The EC Block Exemption for Vertical Agreements Regulation determines the requirements for compatibility of a franchise contract with the EC ban on cartels. It can also be used as a guideline for contract formation.

• Rights and obligations of the franchisor and franchisee

• Goods and services supplied by the franchisor as well as transferred know-how

• Franchisees payment obligations

• Provisions on the use of intellectual property

• Duration of the contract: should be long enough to amortize the initial investment - an initial duration of 10 years is common.

• Conditions under which the contract can be renewed or terminated

• Conditions under which the franchisee can sell the franchised business

• Right of the franchisor to develop the system

• Provisions about the immediate return of the possessions of the franchisor upon termination of the contract and if applicable compensation of the franchisee.

• Control Rights: guidelines on the degree the franchisee is bound to the business concept should be handed to him.

• Possibly: exclusivity of trading, non-competition clauses, contract penalties.

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The nature as mixed contract demands much care when drafting the

contract. Especially the following areas have to be regarded:

Contract drafting: Influence of Other Areas of Law


•Non-competition clauses may only concern the franchise products and the respective area, may not exceed one year and must grant compensation.

Commercial law

•Clauses that may disadvantage the franchisee unduly are subject to review.

•Especially concerned are minimum turnover, alteration, duration and termination clauses as well as warranty disclaimers.

Civil law

•Franchisee that are not already entrepreneurs may have rights to withdrawal.

•The franchisor may be obliged to inform him or conclude the contract in writing.

Consumer protection

•If franchisees economically depend on the franchisor and are obliged to carry out orders they are regarded as employees – special labor law provisions apply.

Labor law

•Vertical distribution structures may fall under the Law Against Restraint on Competition and the European Antitrust Law.

•Especially exclusive minimum purchasing quantities are concerned.

•Price fixing and anticompetitive advertising is forbidden!

Antitrust and

competition law

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Financing of franchising can be tailored to the individual needs. The

following

components are common:

Financing of franchising can be tailored to the individual needs. The

following components are common:

Financing of Franchising


Entry Fee Royalties Investment

Paid for the introduction to the system and includes mostly:

supply of furniture, know-how, first training,

competitive advantage etc.

Payment for the continuous performance

by the franchisor (trainings, development of the system, market

analysis); paid either as a flat rate or as a

percentage of turnover or supply volume

Some franchise systems demand a single

investment to ensure liquidity of the franchisee

Franchisees of systems that fulfill the standard of the „KfW Mittelstandsbank“ can apply for co-

financing by this state owned bank. This standard demands that

• franchisees are guaranteed legal and economic independence

• competition by the franchisee after the termination of the franchise contract is only forbidden

if the duration of the contract is at least 10 years

• the franchise contract is governed by German law or the law of a member of the EU /EFTA

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The core element of a franchise contract is the franchise manual. All

questions that may arise must be addressed. That includes:

Franchise Manual


• Description of the franchise system

• Description of the market situation

• Guidelines on how to run the franchise outlet in terms of

quality and corporate identity; but: the entrepreneurial

freedom of the franchisee cannot be undermined completely.

• Scope of transferred Know-how : serves as proof in case of

disputes

Some franchise systems use the threefold approach meaning the agreement on a compendium that consists of:

1. the franchise contract2. franchise guidelines and 3. franchise manual

The manual can also be provided in an electronic version.

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• Expiration: if fix durations have been agreed upon – durations of 10 years are common.

• Ordinary cancellation: where cancellation periods have been agreed upon in the

franchise contract.

• Extraordinary cancellation: in case of breach of contract extraordinary cancelation by

both parties is always possible.

• Termination agreement: franchisor and franchisee may also conclude a termination

agreement.

• Exclusion: the possibility of termination can be excluded as long as the economical

freedom of the franchisee is not impaired. This is presumed to be the case where it is

excluded for more than 20 years. The individual interval is determined on a case-by-case

basis especially considering the amount of capital invested. That means: The higher the

investment of the franchisee, the longer the period in which termination may be

excluded!

Franchise contracts can be ended through expiration, cancellation or by

agreement

Termination of the Franchise Contract


Fiduciary duties may persist even after termination. These entail especially:• Both the franchisor and the franchisee have to avoid damaging each other.• The franchisor has to take back the goods stored by the franchisee against

repayment of the sales price.

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Trademarks are essential for the functioning of the franchise system. They

give their owner the exclusive right of usage.

Intellectual Property: Trademarks


Protection can be sought for unique words, letters, numbers, pictures,

colors and sounds

International protection can be achieved by filing an application for

registration at a national Industrial Property office of the WIPO (DPMA for

Germany).

To protect a trademark it can be registered with the German Patent and

Trade Mark Office (DPMA).

The initial protection period is 10 years which can be extended

indefinitely if the renewal fee is paid every 10 years.

A Europe-wide community trademark can be registered with the Office for

Harmonization in the Internal Market (OHIM).

The owner can grant licenses that allow the licensee to use the trademark against payment of a fee.

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Intellectual property enjoys a strong protection in Germany. Other

available protection forms include:

Other Intellectual Property Rights


Patent Utility Model Design

Can be granted for inventions that are new, involve an inventive step and are susceptible of industrial application.

Can be granted for the same inventions that are eligible for patents but as opposed to patents utility models are granted without substantive examination of the invention.

Designs protect the outward appearance of a product.They have to be new, peculiar and susceptible of commercial use.

Everyone who has a domicile or seat in Germany is eligible to apply for registrations with the German Patent and Trademark Office. Others can file an application through a lawyer.

The German Act against unfair competition (Gesetz gegen unlauteren Wettbewerb –UWG) also protects the peculiar works of a product against imitation in the competitive behavior, i.e. through the distribution of counterfeits. All unfair commercial activities of competitors are prohibited. If a competitor turns to unfair market practice claims for damages, removal, omission and disclosure may arise or profits be skimmed.

www.gtai.com February 2, 2011 32Franchising in Germany






www.gtai.com

German Franchise Association: www.franchiseverband.com

European Franchise-Federation: www.eff-franchise.com

The World Franchise Council: www.worldfranchisecouncil.org

The German Franchise Institute: www.franchise-institut.de

Internationales Centrum für Franchising & Cooperation: www.franchising-und-cooperation.de

KfW Mittelstandsbank: www.kfw.de/EN_Home/index.jsp

Franchiseportal: www.franchiseportal.de

Franchise.de: www.franchise.de

Infofranchise.de: www.infofranchise.de

Further information can be obtained from the following websites:


Links


http://www.franchiseverband.com/

http://www.eff-franchise.com/



http://www.worldfranchisecouncil.org/

http://www.franchise-institut.de/



http://www.franchising-und-cooperation.de/





http://www.kfw.de/EN_Home/index.jsp

http://www.franchiseportal.de/

http://www.franchise.de/

http://www.infofranchise.de/

www.gtai.com

Tax & Legal


© 2011 Germany Trade & Invest GmbH All information provided by Germany Trade & Invest has been put together with the utmost care. However , we assume no liability for the accuracy of the

information provided.

Tax & Legal ServicesMs. Christina Schön

ManagerT. +49 30 200 099-506F. +49 30 200 099-999

[email protected]

Tax & Legal ServicesMr. Heiko Stumpf

ManagerT. +49 30 200 099-509 F. +49 30 200 [email protected]

Germany Trade and Invest GmbHChief Executives:

Dr. Jürgen Friedrich, Michael Pfeiffer

Friedrichstraße 6010117 BerlinGermanyT. +49 30 200 099-0F. +49 30 200 099-111

Villemombler Straße 7653123 Bonn

GermanyT. +49 228 24 993 -0

F. +49 228 24 993 -212

www.gtai.com

Germany Trade & Invest


or contact

www.gtai.com

Germany Trade & Invest GmbH

Deutsche Anwaltsauskunft(Information Desk of the German Bar Association)www.anwaltauskunft.de

If legal advice is required, please contact a lawyer. To identify the most appropriate lawyer please consult:

If you are looking for a notary, please refer to the register of German notaries:

Deutsche Notarauskunft(German Federal Chamber of German civil law notarieswww.deutsche-notarauskunft.de

© 2011 Germany Trade & Invest GmbH All information provided by Germany Trade & Invest has been put together with the utmost care. However , we assume no liability for the accuracy of the

information provided.

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