Franchising and Licensing Two Powerful Ways to Grow Your Business in Any Economy_11 pot

288 FINANCIAL STRATEGIES ❒ Duty of Care. The directors must carry out their duties in good faith with diligence, care, and skill in the best interests of the corporation. Each di- rector must actively gather information to make an informed decision re- garding company affairs and in formulating company strategies. In doing so, the board member is entitled to rely primarily on the data provided by officers and professional advisors, provided that the board member has no knowledge of any irregularity or inaccuracy in the information. I have seen instances where board members have been held personally responsi- ble for misinformed or dishonest decisions made in bad faith, such as the failure to properly direct the corporation or where the board knowingly authorized a wrongful act. ❒ Duty of Loyalty. The duty of loyalty requires each director to exercise his or her powers in the interest of the corporation and not in his or her own interest or in the interest of another person (including a family member) or organization. The duty of loyalty has a number of specific applications, such as the duty to avoid any conflicts of interest in your dealings with the corporation and the duty not to personally usurp what is more ap- propriately an opportunity or business transaction to be offered to the corporation. For example, if an officer or director of the company was in a meeting on the company’s behalf and a great opportunity to obtain the licensing or distribution rights for an exciting new technology were to be offered at the meeting, it would be a breach of this duty to try to obtain these rights individually and not first offer them to the corporation. ❒ Duty of Fairness. The last duty a director has to the corporation is that of fairness. For example, duties of fairness questions may come up if a direc- tor of the company is also the owner of the building in which the corpo- rate headquarters are leased and the same director is seeking a significant rent increase for the new renewal term. It would certainly be a breach of this duty to allow the director to vote on this proposal. The central legal concern under such circumstances is usually that the director may be treating the corporation unfairly in the transaction, since the director’s self-interest and gain could cloud his duty of loyalty to the company. When a transaction between an officer or director and the company is challenged, the individual will have the burden of demonstrating the pro- priety and fairness of the transaction. If any component of the transaction involves fraud, undue overreaching, or waste of corporate assets, it is likely to be set aside by the courts. In order for the director’s dealings with the corporation to be upheld, the ‘‘interested’’ director must demonstrate that the transaction was approved or ratified by a disinterested majority of the company’s board of directors. In order for each member of the board of directors to meet his or her duties of care, loyalty, and fairness to the corporation, the following general guidelines should be followed: ❒ The directors should be furnished with all appropriate background and financial information relating to proposed board actions well in advance 10376$ CH14 10-24-03 09:38:22 PS 289 MANAGEMENT AND LEADERSHIP ISSUES IN BUILDING A SUCCESSFUL FRANCHISING ORGANIZATION of a board meeting. An agenda, proper notice, and a mutually convenient time, place, and date will ensure good attendance records and compliance with applicable statutes regarding the notice of the meetings. ❒ Remember that a valid meeting of the board of directors may not be held unless a quorum is present. The number of directors needed to constitute a quorum may be fixed by the articles or by-laws, but is generally a major- ity of board members. ❒ Work with your attorney to develop a set of written guidelines on the basic principles of corporate law for all officers and directors. Keep the board informed about recent cases or changes in the law. ❒ Many of these guidelines, albeit in a diluted format in some cases, can be adopted to govern the selection and operation of the company’s Advisory Boards. ❒ Work closely with your corporate attorney. If the board or an individual director is in doubt as to whether a proposed action is truly in the best interests of the corporation, consult your attorney immediately—not after the transaction is consummated. ❒ Keep careful minutes of all meetings and comprehensive records of the information upon which board decisions are based. Be prepared to show financial data, business valuations, market research, opinion letters, and related documentation if the action is later challenged as being ‘‘unin- formed’’ by a disgruntled shareholder. Well-prepared minutes will also serve a variety of other purposes such as written proof of the director’s analysis and appraisal of a given situation, proof that parent and subsid- iary operations are being conducted at arm’s length and as two distinct entities, or proof that an officer did or did not have authority to engage in the specific transaction being questioned. ❒ Be selective in choosing candidates for the board of directors. Avoid the consideration or nomination of someone who may offer credibility but is unlikely to attend any meetings or have any real input to the management and direction of the company. It is often the case that the most high-profile business leaders are spread too thin with other boards and activities to add any meaningful value to your growth objectives. In my experiences, such a passive relationship will only invite claims by shareholders for corporate mismanagement. Avoid inviting a board candidate who is al- ready serving on a number of boards in excess of five to seven, depending on their other commitments. Similarly, don’t accept an invitation to sit on a board of directors of another company unless you’re ready to accept the responsibilities that go with it. ❒ In threatened takeover situations or friendly offers to purchase the com- pany, be careful to make decisions that will be in the best interests of all shareholders, not just the board and the officers. Any steps taken to de- fend against a takeover by protecting the economic interests of the officers and directors (such as lucrative golden parachute contracts that ensure a costly exit) must be reasonable in relation to the threat. ❒ Any board member who independently supplies goods and services to the corporation should not participate in the board discussion or vote on any 10376$ CH14 10-24-03 09:38:23 PS 290 FINANCIAL STRATEGIES resolution relating to his or her dealings with the corporation in order to avoid self-dealing or conflict-of-interest claims. A ‘‘disinterested’’ board must approve proposed actions after the material facts of the transaction are disclosed and the nature and extent of the board member’s involve- ment is known. ❒ Questionnaires should be issued periodically to officers and directors re- garding possible self-dealings or conflicts of interests with the corpora- tion. Incoming board members and newly appointed officers should be provided with a more detailed initial questionnaire. These questionnaires should also always be circulated among the board prior to any securities issuances (such as a private placement or a public offering). ❒ Don’t be afraid to get rid of an ineffective or troublesome board member. Don’t let the board member’s ego or reputation get in the way of a need to replace them with someone who is more committed or can be more effec- tive. It may be best to avoid probably close friends on the board of direc- tors who may be either difficult to terminate or become lazy in the execution of their duties because of the friendship. Maintain the quality of the board and measure it against the growth and maturity of the company. Emerging businesses tend to quickly outgrow the skills and experiences of their initial board of directors who need to be replaced with candidates with a deeper and wider range of experiences. Try to recruit and maintain board members who bring ‘‘strategic’’ benefits to the company, but who are not ‘‘too close for comfort’’ in that their fiduciary duties prevent them from being effective because of the potential conflict of interests. This is especially true for your outside team of advisors, such as attorneys and auditors, who may not be able to render objective legal and accounting advice if they wear a second hat as a board of director member. It may be easier for these professionals to sit on your Advisory Board, however, which is less likely to cause conflicts. ❒ Board members who object to a proposed action or resolution should ei- ther vote in the negative and ask that such a vote be recorded in the min- utes, or abstain from voting and promptly file a written dissent with the secretary of the corporation. Following these rules can help ensure that your board of directors meets its legal and fiduciary objectives to the company’s shareholders and also pro- vides strong and well-founded guidance to the company’s executive team to help ensure that growth objectives are met. Corporate Governance and Reporting in the New Age of Scrutiny: Understanding the Obligations of Franchisors in a Post—Sarbanes-Oxley Environment Since the collapse of Enron, Andersen, and Worldcom, and investigations at AOL Time Warner, Tyco, Qwest, Global Crossing, ImClone, and many more, the public’s trust in our corporate leaders and financial markets—either as employees, shareholders, or bondholders—has been virtually destroyed. And we all can agree that the market did not need this corporate governance 10376$ CH14 10-24-03 09:38:23 PS 291 MANAGEMENT AND LEADERSHIP ISSUES IN BUILDING A SUCCESSFUL FRANCHISING ORGANIZATION crisis at this time; there was already plenty of factors at work in rattling investor psyche, from the war with Iraq, to the fighting in the Middle East, to threats of additional terrorist attacks on U.S. soil, to the disputes between Pakistan and India, coupled with the market corrections that we have all suffered through since March 2000. So what can be done to rebuild the public’s trust and confidence? At the heart of the solution to the problem is a return to the fundamentals of what it means to serve as an executive or as board member of a publicly traded or emerging growth privately held company. Our corporate governance laws created duties of care, duties of fairness (to avoid self-dealing and conflicts of interests), duties of due diligence, duties of loyalty, and the business judg- ment rule to help ensure that we all serve on boards, advisory councils, or committees primarily for the purposes of serving others, to help, to guide, to mentor—to be a fiduciary and to look out for the best interests of the com- pany’s shareholders, not to perpetuate greed or fraud. We seem to have lost sight of our responsibility to those constituents that the laws dictate that we serve. In response, Congress acted relatively swiftly in passing the Sarbanes- Oxley Act, which the president signed into law on July 30, 2002. The SEC, NYSE, DOJ, NASDAQ, state attorney generals, and others have also re- sponded quickly to create more accountability by and among corporate exec- utives, board members, and their advisors to shareholders and employees. Central themes include more objectivity in the composition of board mem- bers, more independence and autonomy for auditors, more control over fi- nancial reporting, stiffer penalties for abuse of the laws and regulations pertaining to corporate governance, accounting practices, and financial re- porting, and new rules to ensure fair and prompt access to the information and current events that affect the company’s current status and future per- formance. The objectives of the legislation include: ❒ Swift congressional reaction to abuses in order to restore and rebuild public trust and confidence (shareholders will not tolerate being in the dark) ❒ Greater transparency and truth in financial reporting (need for com- plete, relevant, and reliable data) ❒ Protection of objectivity and accountability in board operations and ex- ecutive decision making ❒ Full, fair, and prompt disclosure of material developments ❒ The end of cronyism (cost-benefit analysis makes serving on boards look generally unattractive) ❒ Political maneuvering to create budgets for vigilant enforcement (in- creases in SEC funding) ❒ Raised stakes (the risk and magnitude of personal liability for officers and directors of public companies has been significantly increased) 10376$ CH14 10-24-03 09:38:24 PS 292 FINANCIAL STRATEGIES The Sarbanes-Oxley Act of 2002 ❒ Creation of a Public Company Accounting Oversight Board to regu- late public accounting firms and ensure auditor independence. The Board will be under the authority of the SEC ❒ Stricter requirements for the independence of auditors and audit committees ❒ CEOs and CFOs are required to certify financial statements, under threat of civil and criminal penalties for false certifications ❒ Prohibition of loans to executives and directors ❒ Accelerated reporting of insider trading ❒ Blackout period for trading in retirement fund equities by directors and officers under Section 16 ❒ Increased disclosure requirements, including certain categories of information that must be disclosed rapidly and currently ❒ Requirement that attorneys report material violation of securities law or breach of fiduciary duty to the chief legal counsel or CEO ❒ Stricter civil and criminal penalties for securities and violations ❒ Application of securities laws to foreign issuers Yes, we are truly entering a new age of scrutiny—an era of validation and verification. The role of the board and its committees is being redefined, reex- amined, and retooled. A new set of best practices, procedures, and protocols are being written as we speak, and this process will continue into 2003 and beyond. Internal controls and systems need to be designed to ensure compli- ance with these new rules of the game and managers must be held account- able for enforcement and results. The CEO’s new job description reads ‘‘Forget the Gravy, Where’s the Beef?’ and includes less pay, fewer perks, and less power in exchange for more performance and less tolerance for error or abuse. CEOs must live in a new era that will feature more accountability and shorter tenure. Yet, the key question remains: Can we truly legislate and mandate trust, integrity, and leadership? Will new laws and stock exchange guidelines truly restore public confidence in the markets and get directors and officers fo- cused on the standards of diligence, commitment, and responsibility? How far does any proposed legislation, which is still on the horizon, need to go to get officers and directors truly focused on their most important task— maximizing bona fide shareholder value? In this new era, building shareholder value must be done the old-fashioned way—not via exaggerated revenues, the mischaracterization of expenses, the use of special-purpose entities to disguise debt obligations, or the use of cre- ative accounting to inflate earnings. The recapturing of shareholder trust will be a costly and time-consuming process. Both institutional and individual 10376$ CH14 10-24-03 09:38:24 PS 293 MANAGEMENT AND LEADERSHIP ISSUES IN BUILDING A SUCCESSFUL FRANCHISING ORGANIZATION investors must get past their disgust for the greed and negligence shown by some of our corporate leaders, such as Dennis Kozlowski of Tyco (evasion of sales tax in connection with artwork purchases) and John Rigas and family at Adelphia (embezzlement and misuse of corporate assets). A recent study by the Pew Forum demonstrated that Americans now think more highly of Washington politicians than they do of business leaders. As John Bogle, founder of Vanguard funds, has often said, ‘‘Investing is an act of faith.’’ The events of the past 12 months have lead most investors to lose faith in the integrity of the system and the markets. If investors lose faith in the trustwor- thiness of the teams leading corporate America and in the accuracy of the data in financial reports, our capital markets can’t function and our economy will break down. Is this the inevitable path we are on? Are the current chal- lenges insurmountable? I don’t think so. But just as Congress and the White House acted swiftly to pass the Sarbanes-Oxley Act and prosecutors made quick decisions to indict Worldcom and Adelphia executives, corporate leaders must act swiftly to adopt changes and revise practices at their compa- nies as steps to recapturing shareholder trust and to avoid the need for future legislation, which may be much more burdensome than the recently adopted laws and regulations. As corporate executives, you also owe a duty to your shareholders, em- ployees, and strategic partners to adopt new procedures and comply with these new laws in order to avoid the widespread damage that is done when an entire corporation is indicted as opposed to merely the individual wrong- doers. Andersen’s downfall adversely affected 26,000 employees as well as thousands of clients, vendors, subcontractors, and strategic partners—all of which presumably had done nothing wrong. The Impact on Privately Held Companies Why do privately held franchisors need to be aware of the requirements of Sarbanes-Oxley? There are at least 12 reasons. The requirements of this legis- lation are likely to have a trickle-down or indirect effect on nonpublic com- panies as follows: 1. There is a new emphasis on accountability and responsibility in corpo- rate America that affects board members and executives of companies of all sizes as shareholders look for better and more informed leadership. 2. Some of the corporate governance provisions of Sarbanes-Oxley are likely to evolve into ‘‘best practices’’ in business management over the next decade and other provisions merely reinforce state corporate law requirements that have already been in place for many years, which gov- ern all corporations and limited liability entities. Since corporate law is generally made at the state level, entrepreneurs of privately held compa- nies should keep a close watch on developments in their state of incor- poration. 3. It is highly likely that insurance companies, which issue D&O insurance and related policies, will require Sarbanes-Oxley compliance as a condi- 10376$ CH14 10-24-03 09:38:25 PS 294 FINANCIAL STRATEGIES tion to the issuance of new policies or as a condition to obtaining favor- able rates. 4. Employees at all types of companies as well as prospective franchisees are generally placing a new focus on ethics and honest leadership as a condition to staying on board or loyalty to the company. 5. Venture capitalists and other private-equity key players have a tendency to mimic developments in the public-equity markets when structuring deals and may begin inserting Sarbanes-Oxley–type provisions regard- ing executive compensation governance, auditor autonomy, reporting, and certification of financial statements into their Term Sheets. 6. Privately held franchisors who may be positioning themselves for an eventual sale to a public company will want to have their governance practices, accounting reports, and financial systems as close to the re- quirements of Sarbanes-Oxley as possible in order to avoid any problems in these areas serving as impediments to closing (be ready for a whole new level of due diligence questions in M&A that focus on governance practices and that dig deeper on financial, compensation, and account- ing issues). 7. Board member recruitment at all levels is likely to be more difficult even for privately held companies given that the perceived risk of serving as a director is higher and the general cost-benefit analysis seems to fall short on the side of accepting an offer. Once accepted, expect board members to be more focused, more vocal, more inquisitive, and more likely to ask the hard questions and to want detailed and substantiated answers. 8. Commercial lending practices are likely to change a bit in response to Sarbanes-Oxley for borrowers of all types. Be ready for conditions to closing and loan covenants that focus on strong governance practices, board composition issues, certified financial reporting, and the like. 9. We are now in an era where it is critical to build systems and procedures for better communications by and among the board and its appointed executives; the board and the shareholders; the executives and the em- ployees; and the company and its stakeholders. There is a renewed em- phasis on independence, autonomy, ethical leadership, open-book management, accountability, responsibility, clarity of mission, and full disclosure that these systems and procedures need to create for all of corporate America. 10. The requirements of Sarbanes-Oxley must be adopted by publicly traded companies and understood by privately held companies but are also beginning to make their way into the management and governance prac- tices at nonprofits, trade associations, business groups, academic institu- tions, cooperatives, and even government agencies where any form of poor management, corruption, embezzlement, or questionable account- ing practices cannot be and will not be tolerated. 11. Sarbanes-Oxley was passed in part to help restore confidence in the pub- lic capital markets. Until these laws have their intended effect and the 10376$ CH14 10-24-03 09:38:25 PS 295 MANAGEMENT AND LEADERSHIP ISSUES IN BUILDING A SUCCESSFUL FRANCHISING ORGANIZATION public markets begin to rebound, entrepreneurs and executives at pri- vately held companies are likely to continue to run into strong barriers to capital formation. The shrinkage in public company valuations and the virtual shutdown of any exit strategies means that less venture capi- tal and private equity capital will be placed, especially to new projects (e.g., vs. follow-on investments to existing portfolio companies) and when it does get placed, be ready for tougher terms and lower valuations. 12. Getting deals done will be tougher in a post–Sarbanes-Oxley environ- ment. Many of the highly acquisitive companies (e.g., Tyco, Sun, Cisco, etc.) have had their accounting practices called into question and some of our biggest mergers (e.g., AOL-TimeWarner) do not appear to be work- ing very well. The appetite for doing M&A deals seems to have faded, except for the value players, distressed company buyers, and bottom fishers. The fraud behind Enron’s many phony partnerships has even created some hesitation in the willingness of larger companies to partner with smaller ones in a joint venture or strategic alliance structure. Both publicly held and privately held franchisors should be committed to creating a corporate governance process that restores the integrity of the com- pany’s leadership in the eyes of the shareholders and employees, creates truly informed Board members who have the power to act based on timely and accurate information, and that protects the authority and fosters the courage of the Board to take whatever acts necessary to fulfill its fiduciary obligations. In reexamining the roles, functions, and responsibilities of Board members, it is no longer sufficient to merely make a periodic meaningful contribution to the strategic direction of the company; rather, directors must now be more proactive as defenders of the best interests of the shareholders and to the employees, participants, and beneficiaries of pension, 401(k), and stock option plans. Board members and corporate leaders should assume that their meetings will be in ‘‘rooms with glass walls’’ and their actions will be examined under a microscope at least until general market confidence is restored. 10376$ CH14 10-24-03 09:38:26 PS This page intentionally left blank C HAPTER 15 The Role of the Chief Financial Officer and Related Financial and Administrative Management Issues As discussed in Chapter 13, as a franchisor grows and matures, its manage- ment team must also evolve to meet new challenges and solve new problems. In the early stages, the management team of the franchisor is heavily focused on sales and marketing, which is often a necessary prerequisite to building a critical mass of franchisees. But as the emphasis shifts from franchise sales to service and support, additional personnel must be recruited in the areas of operations, administration, and finance. The management teams of many rapidly growing franchisors often lack experienced financial officers who can bring economic discipline to the organization and perform ongoing analysis of the company’s business model. Effective financial management, reporting systems, and analysis are the keys to the ongoing success of a growing fran- chise system. When a franchisor reaches that critical stage of growth when it is neces- sary to hire a full-time financial officer, the first reaction is typically panic. First, because the position must be added to the overhead; and second, be- cause they don’t know where to start looking. Even the well-respected and well-recognized executive recruitment firms that specialize in franchising admit that there is a lack of truly qualified and experienced financial manag- ers. Many franchisors have unsuccessfully recruited from the accounting profession, which can result in the placement of an individual who is very well trained in the areas of accounting or tax planning, but may lack the operational experience to truly understand the special financial dynamics of the franchisor-franchisee relationship. The ideal candidate will have had some initial training as a certified public accountant but will also have had ‘‘hands-on’’ experience as a CFO or comptroller of a franchise company, or at least with a firm that has a structure and method of distribution and growth similar to franchising such as dealerships, retailing, or licensing. The overall task of the CFO is to manage the cash flow and profitability of the franchisor. The three cost areas that must be managed carefully are: (1) recruitment costs, such as marketing, advertising, trade shows, marketing personnel, etc.; (2) preopening costs, such as the costs to get the franchisee up and running including training, site selection, and other types of preopen- 297 10376$ CH15 10-24-03 09:38:22 PS [...]... on the employee not to disclose (in any form and to any unauthorized party) any information that the franchisor regards as confidential and proprietary This should include, among other things, customer lists, formulas and processes, financial and sales data, agreements with customers and suppliers, business and strategic plans, marketing strategies and advertising materials, and anything else that gives... this information in the initial training program, the operations manual, and in periodic updates and bulletins to ensure that franchisees have access to this information but at the same time be careful not to cross the line into what may be perceived as interference with the day -to- day management of the franchisee’s business, which may lead to vicarious liability In recent years, employees and other injured...F IN AN CI AL ST RATE GI ES 298 ing assistance; and (3) maintenance costs, such as the various ongoing training and support costs to maintain a healthy and mutually profitable relationship The CFO’s job is to continue to study the financial model between the franchisor and the franchisee, such as the pricing of the initial franchise fees (which are designed to cover 1 and 2, above) and the rates... be told to prospective employers and reminded of any covenants not to compete and of the employee’s continuing obligation to protect the company’s trade secrets 5 The fifth and final step is to prepare a comprehensive release and termination to further protect the company against subsequent litigation The employee should be given an opportunity to have it reviewed by legal counsel The release and termination... application and in the interview ❒ Any selection criteria, testing, or related performance measure implemented in the decision-making process ❒ Any differences in the terms and conditions of employment offered to those who apply for the same job Anyone alleging discrimination in the hiring process would need to demonstrate that the following key facts were present: 1 That the applicant was a member of a minority... services in the system in a profitable fashion The franchisor must also take steps to negotiate volume discounts and develop cost-management training for the benefit of the franchisees, recognizing that profitability is a combination of increasing sales and controlling costs The franchise fee and royalty structure should continue to be analyzed to ensure that it is in line with current market trends and actual... general strategic planning The results of these meetings are used to improve overall performance as well as to provide a basis for future business and estate planning The CFO can also use this data to develop a set of ‘‘financial best practices’’ to disseminate this information into the field as well as update training programs and operations manuals The franchisees generally respond well to this peer-driven... the right to approve all modifications to a franchise did not permit the franchisor to require an existing franchisee to make modifications to an existing structure Furthermore, there was no showing that the franchisor exercised its approval rights in any way inconsistent with the disabilities law A franchisor might be subject to liability for refusing to approve plans to bring a franchise into compliance... in connection with the termination of an employee In order to successfully defend against these types of claims, you must be prepared to demonstrate that employee performance evaluations, policies contained in personnel manuals, and grounds for termination were implemented and enforced in a nondiscriminatory fashion and not as a result of any act contrary to applicable federal law Specific, clear, and. .. federal and state level of regulation Preparing the Personnel Manual A rapidly growing franchisor should develop a personnel manual and handbook for the purposes of communicating to all of its employees the details of its management procedures and guidelines Some of these recommended policies and compliance tools should also be included in your operations manual for distribution to your franchisees F IN . have lead most investors to lose faith in the integrity of the system and the markets. If investors lose faith in the trustwor- thiness of the teams leading corporate America and in the accuracy. regulations pertaining to corporate governance, accounting practices, and financial re- porting, and new rules to ensure fair and prompt access to the information and current events that affect the company’s. high-profile business leaders are spread too thin with other boards and activities to add any meaningful value to your growth objectives. In my experiences, such a passive relationship will only invite