1. About Franchising and Leasing
Commercial economics week 5

2. Commercial economics week 5
Describe the significance of franchising
Identify the major advantages and limitations of franchising
Discuss the process for evaluating a franchise opportunity.
Evaluate franchising for the franchisor’s perspective.
Describe the franchisor/franchisee relationship.
Commercial economics week 5

3. Commercial economics week 5
Franchising Terms
Franchising
A marketing system revolving around a two-party legal agreement, whereby the franchisee conducts business according to the terms specified by the franchisor
Franchise contract
The legal agreement between franchisor and franchisee
Franchise
The privileges conveyed in the franchise contract
…continued
Commercial economics week 5

4. Commercial economics week 5
Franchising Terms
Franchisee
An entrepreneur whose power is limited by a contractual agreement with a franchisor
Franchisor
The party in the franchise contract that specifies the methods to be followed and the terms to be met by the other party
Commercial economics week 5

5. Commercial economics week 5
Types of Franchises
Product and Trade Name Franchise
Grants the right to use a widely recognized product or name
Business Format Franchise
Provides an entire marketing system and ongoing guidance from the franchisor
Piggyback Franchising
The operation of a retail franchise within the physical facilities of a host store
…continued
Commercial economics week 5

6. Commercial economics week 5
Types of Franchises
Master Licensee
An independent firm or individual acting as a sales agent with the responsibility for finding new franchises within a specified territory
Multiple-Unit Ownership
Holding by a single franchisee of more than one franchise from the same company
Area Developers
Individuals or firms that obtain the legal right to open several franchised outlets in a given area
Commercial economics week 5

7. The Pros and Cons of Franchising
Pluses
Minuses
Formalized training
Financial assistance
Proven marketing methods
Managerial assistance
Quicker startup time
Overall lower failure rates
Franchise fees
Royalties
Restrictions on growth
Less independence in operations
Franchisor may be sole supplier of some supplies
Termination/renewal clauses
Figure 3-2
Commercial economics week 5

8. The Advantages of Franchising
Proven marketing concept and customer base
Training
Financial assistance
Operating assistance
Commercial economics week 5

9. Commercial economics week 5
Financial Assistance
Start-up business costs are normally high and thus by teaming up with a franchise organization, the individual can increase her/his chance of receiving financial help.
The franchisor might chose to use liberal payment schemes to the franchisee in order to get over the initial financial hurdle.
Commercial economics week 5

10. Commercial economics week 5
Operating Assistance
The franchisor provides a range of operating services including site selection, bulk purchasing of equipment, and inventory.
Other areas of assistance include the use of an established, nation-wide brand
Commercial economics week 5

11. Pros and Cons of Franching
Advantages
Probability of success
Proven line of business
Pre-qualification of franchisee
Training
Franchisor-provided
Financial assistance
Franchisor assistance
Operating benefits
Franchisor-aided
Limitations
Franchise costs
Initial franchise fee
Investment costs
Royalty payments
Advertising costs
Restrictions on Business Operations
Loss of independence
Commercial economics week 5

12. Limitations of Franching: Restriction of Business Operations
Restricting of sales territory
Requiring site approval and imposing requirement on the outlet’s appearance
Restricting the goods/ services that can be sold
Restricting the resale of
the franchise without their permission
Restricting advertising and hours of operation
Commercial economics week 5

13. Evaluating Franchise Opportunities
Locating a Franchise Opportunity
Investigating the Potential Franchise
Information sources
Independent, third-party sources
Franchisors themselves
Existing and previous franchisees
Commercial economics week 5

14. Commercial economics week 5
Explanation of Costs
Franchise fee
First and Last Month’s Rent
Leasehold Improvements
Equipment
Furniture and Fixtures
Signage
Insurance, Licences and Permits
Training
Initial Inventory
Working Capital
Royalty
Commercial economics week 5

15. Global Franchising Opportunities
Historically, many Canadian franchisors have expanded into the United States.
Canadian franchising enterprises are now expanding into countries beyond North America.
Commercial economics week 5

16. Investigating the Franchise Candidate
Three sources of information:
independent third party sources
franchisors
existing and previous franchisees
Commercial economics week 5

17. Commercial economics week 5
Selling a Franchise
Why would a businessperson wish to become a franchisor? Three benefits can be identified:
Reduction of capital requirements
Increase in management motivation
Speed of expansion
…continued
Commercial economics week 5

18. Commercial economics week 5
Selling a Franchise
Drawbacks associated with franchising from the franchisor’s perspective.
Reduction in control
Sharing of profits
Increase in operating support
Commercial economics week 5

19. Commercial economics week 5
Franchising Frauds
The Rented Rolls Royce Syndrome
The Hustle
The Cash-Only Transaction
The Boast
The Big-Money Claim
The Couch Potato’s Dream
Location, Location, Location
The Disclosure Dance
Commercial economics week 5

20. Commercial economics week 5
LEASING and Cross border transactions
Transaction imperatives
Key tax and financial considerations
Income stream
Entry strategy
Financing options
Debt structuring
Cash repatriation
Exit considerations
Key tax and financial considerations
Case Study
Business reorganisations
Leasing transactions
Commercial economics week 5

21. Cross border transaction imperatives
Cross Border Transactions
Legal & regulatory framework
Identifying and delivering synergies
Tax regimes & treaties
Business Dynamics
Business Environment
Cultural Issues
Accounting treatment
Cultural Differences:
In a multi-disciplinary context, sparked in the wake of globalization, various issues concerning inter-country cultural differences have assumed significant importance. A lack of an optimum level of understanding of the contracting parties’ spoken language, its culture, the traditions, its local business practices and customs, can have an adverse impact on an effective completion and implementation of the project/transaction resulting in the ultimate break down of the business relationship.
Business Strategies:
A successful business venture is dependant on a number of factors and strategies. These include factors driving demand and customer loyalty, level of quality of service, industrial practices, or distribution channels. All of which would differ on a country-to-country basis depending upon the extent of liberalization and privatization and the model of governance being followed there. These issues, therefore, gain significance at the early stages of implementation of a cross border transaction.
Accounting Treatments:
Differences exist across countries, on the varying accounting treatments practiced such as financial reporting and the quantity of financial information made available. In cross border transactions, such issues must be addressed at an early stage so as to address the risk quotient of the transaction.
Identifying and Delivering Synergies
Cross border transactions may be structured in numerous forms, however, the ultimate objective of all such transactions is to achieve synergies by benefiting from each other’s expertise and exploiting maximum available potential on either side. Thus, any cross border transaction must be structured keeping a synergies plan in mind prior to its implementation so that maximum benefits may be reaped at a later stage.
Laws and Regulations:
The level of corporate governance varies from country-to-country as also the willingness to open its markets to foreign investors. The legal and regulatory framework varies across the globe, some being more stringent than others. Local expertise is therefore essential to provide an in depth understanding of the relevant local laws and regulations.
Tax regimes and treaties
Local laws and regulations when juxtaposed against relevant cross border tax treaties, offer a complete understanding of the legal liabilities and duties of an entity, entering into a cross border transaction. Principally designed to avoid double taxation, these tax treaties often give rise to complex issues and tackling the same may require expertise and specialization.
Environment:
On similar lines as cultural concerns, other civil society concerns may also arise such as those involving national and international environmental NGOs. A business concern may face significant risk, even if it has complied with the law, from these lobby groups, which may hamper the company’s reputation globally if the standards maintained by the company are below international or western standards. Such and other local variants must be integrated with the wider financial and commercial due diligence findings of the company.
Commercial economics week 5

22. Cross border transactions Income flows and their taxability
Key tax and financial considerations
Cross border transactions
Exit considerations
Cash repatriation
Debt Structuring
Income flows and their taxability
Entry Strategy
Financing options 1 2 3 4 5 6
Commercial economics week 5

23. Income stream and their taxability1
Income stream and their taxability
Income streams
Principles for evaluation
Interest, TS and royalty can flow independent of ownership pattern
TS and royalty would typically flow to an operating entity, which possess technical capabilities
Principal drivers are tax costs associated with dividend flows and gains on disposal of shares
Brand fee would flow to the IPR company
Dividends
Capital gains
Interest
Others: royalty / brand fees / technical services / management services
Key elements – arm’s length principle, documentation, overall tax costs and foreign tax credits
Commercial economics week 5

24. Financing options 3 Parameters Equity Debt (related & third party)
Quasi Debt (Preference stock – mezzanine instrument )
Term
Long Tem
Medium to long term
Pay outs
Dividend
Interest
Tax rate
DDT %
Withholding 0 / 10 / 15 / 20%
DDT would be %
Tax credit
Not available under most Treaties (check domestic laws of home country)
Tax withholding on interest available
Usage
No restrictions
Restriction on usage as per ECB guidelines (see next slide)
Deductibility
Dividends and DDT not deductible
Interest allowed as deduction (arm’s length principle)
Dividends and DDT not deductible; consider double dip deduction
No thin capitalisation norms and hence an Indian company can be highly leveraged if it meets commercial requirements
Leveraging Indian company using overseas debt subject to restrictions in ECB Guidelines (see next slide)
Commercial economics week 5

25. Debt structuring 4 Lenders Amount/ maturity End use Total cost of debt
Internationally recognized sources (international banks, capital markets, multilateral financial Institutions, equipment suppliers, foreign collaborators)
Foreign equity holder if:
ECB up to 5 MUSD – minimum equity of 25%
ECB above 5 MUSD – minimum equity of 25% and debt-equity ratio not exceeding 4:1
Lenders
Amount/ maturity
Upto 20 MUSD – Minimum average maturity of 3 years, can have call / put option
Over 20 MUSD to 500 MUSD – Minimum average maturity of 5 years
ECBs outside the above limits/ maturity period need specific approval
Investment in real sector (capital goods, new projects, modernization/ expansion of units)
Investment in Infrastructure sector (power ,telecommunication, railways, roads, ports etc)
Not to be utilized in capital market transactions, real estate, acquisition, working capital, repayment of Rupee loans
End use
Total cost of debt
ECBs with minimum average maturity of 3-5 yrs: 200 bps above six month LIBOR
ECBs with minimum average maturity of more than 5 yrs: 350 bps above six month LIBOR
ECBs upto 200 MUSD can be pre-paid without approval subject to compliance with minimum average maturity period
Prepayment
MUSD means million United States Dollars
Commercial economics week 5

26. Commercial economics week 5
Cash repatriation
Suitability
Dividend distribution
Profit making company
Ease of repatriation
Simplest and most common
Capital reduction
Cash rich company with low reserves
Loss making company with cash reserves
Maximum amount of repatriation desired
Court regulated process, involving repayment of share capital – comparatively complex and time consuming – amount paid to the extent of accumulated profits of the company would be taxable as dividend in India
Share buyback
Profit making company
Foreign Co desires to classify the income as ‘capital gains’ instead of ‘dividend’ – possible treaty benefits
Repurchase of shares – restricted amount of repatriation – income taxable as capital gains in hands of the shareholder
Broad mechanics of each of the above options have been discussed in detail in Annexure 1
Commercial economics week 5

27. Commercial economics week 56
Exit considerations
Capital gains
No Objection Certificate requirement for setting up new venture – Press note 1 of 2005 (refer Annexure 2 for process)
Shareholder’s agreement and implications thereof –
Right of First Refusal; Tag Along rights; Drag Along rights
Liquidation process – long drawn and Court approval process
Commercial economics week 5

28. Case Study – acquisition of business
US Corp
Target Co
Indian
Mauritian Co
Indian Partner
Global conglomerate engaged in diversified businesses
Aggressively targeting Asian foods markets
Has significant experience in the foods business and commands a powerful brand name
Controls significant share of the Indian foods market
Leading exporter to Asia
Strong track record and substantial reserves
US Corp’s strategic holding company for Asian investments
Has a wholly owned Indian subsidiary, F&P, engaged in two businesses - foods and packaging
F&P has accumulated tax losses
Leading Indian company (not part of US Corp group)
Holds majority equity in Target Co
Commercial economics week 5

29. Overview of the structure
Case Study to suggest mechanism to achieve business objectives of US Corp & Indian Partner
Business strategy
US Corp
Phase I
Asian strategy - acquire control of Target Co
Foods business of F&P to be consolidated with Target Co
US Corp
(conglomerate)
USA
100%
Mauritian Co*
100%
Phase II
Target Co sells trademark to US Corp
US Corp licenses trademark to Target Co
US Corp receives royalty
Mauritius
43%
Target Co
(Foods)
India
Indian Partner
57%
Redefining strategy
Focus on core business - auto ancillary
Exit non-core business
Indian Partner
Auto ancillary
Foods & Packaging
*Consider Singapore jurisdiction
Commercial economics week 5

30. Case study - modes of acquisition
Increase in stake
Business restructuring
Direct increase
Passive increase
Acquisition of shares
Preferential allotment of shares
Capital reduction of identified shares
Share buyback
Merger
Demerger
Sale of business undertaking/ sale of assets
The case study however discusses the implications arising under the merger option, in detail in following slides
Commercial economics week 5

31. Phase I - Mechanics of merger
100%
Mauritius Co
51%
43%
Target Co
Foods & Packaging
Merger
Indian
Partner
57%
49%
Present scenario
Issue of shares to Mauritius Co. as consideration of food business
Post Merger
Fiscal and regulatory implications of merger
Company Law Implications
Tax Implications
Other Implications
Special resolution
Court approved process
Dissolution of F&P under Court order without winding up
Broadly tax neutral on satisfying conditions
Transfer of tax losses and tax benefits of F&P
Tax losses available for fresh lease of 8 years
Stamp duty costs significant
Valuation of companies
No foreign investment approvals, subject to conditions
No cash outflow for Mauritian Co
No consideration to Indian Partner on indirect dilution of its stake
Commercial economics week 5

32. Phase II – Sale and license back of trademark
Mechanics
Mauritian Co
Target Co transfers its Trademark (‘TM’) to Mauritian Co. Subsequently Mauritian Co licenses TM back to Target Co
51%
Mauritius
License of trademark – royalty income
India
Sale of trademark – capital gains
Target Co
Arm’s length nature of sales and licensing of trademark
May entail service tax and Value Added Tax
Commercial economics week 5

33. Leasing transactions Salient features of leasing transactions
Wet lease
Lease of equipment with resources to operate the equipment
Lessor continues to control the operation of the equipment and its maintenance
Example– Lease of an aircraft along with flight crew; lessor responsible for selection/ hiring of flight crew, operation and maintenance of
aircraft, etc
Dry lease
Lessor merely provides the equipment at a particular location
Lessee operates the equipment using his own resources
Example – Lease of aircraft without crew
Forms of dry lease:
Operating lease
Finance lease
Commercial economics week 5

34. Operating Lease vs. Finance Lease
Lessor is the legal and the economic owner
Lessor is the legal owner
Lessee is the economic owner
Risks and rewards associated with the asset not substantially transferred
Risks and rewards associated with the asset are substantially transferred
Risks include the possibilities of losses from idle capacity or technological obsolescence and of variations in return due to changing economic conditions.
Rewards may be represented by the expectation of profitable operation over the economic life of the asset and of gain from appreciation in value or realization of residual value.
According to AS 19, whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than its form.
Examples of situations stated in AS 19 which would normally lead to a lease being classified as a finance lease are:
A) the lease term is for the major part of the economic life of the asset even if title is not transferred;
B) at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and
C) the leased asset is of a specialized nature such that only the lessee can use it without major modifications being made.
Risks include losses due to idle capacity, technological obsolescence & changing economic conditions. Rewards include expectation of profitable operation over economic life of asset and gain from appreciation in value or realisation of residual value
Source: Accounting Standard 19 issued by the Institute of Chartered Accountants of India
Commercial economics week 5

35. Taxation of leases – domestic law
Wet lease
Dry lease
Lessor
Royalties - Section 9(1)(vi) Or
Section 44BBA - 5% of deemed profits
Lessee
Lease rentals allowed as deduction
Depreciation allowed to lessor
Lessor
Royalties - Section 9(1)(vi) Or
Section 44BBA – 5% of deemed profits
Lessee
Resident - Lease rentals would be allowed to the lessee
Depreciation would be allowed to the lessor
Section 10(15A) – exemption from tax withholding extended
Section 9(1) (vi) –
Royalties defined to include payments received for use of equipment by the lessee
It may be argued that in a wet lease the lessee does not use the equipment
However, in a Satellite taxation ruling, it has been mentioned that ‘use’ does not refer to physical use of the equipment
44B/ 44BBA –
These sections apply to non residents engaged in operation of ships and aircrafts and who derive income from carriage of passengers, goods, etc.
Operator not defined with reference to this section but lessor may be held to be the operator because even though aircraft/ ship are operated under the name of the lessee –all functions pertaining to operation of the aircraft/ ship are performed by the lessor such as:
actual flying of the aircraft,
provision of crew for the aircraft, flight planning and related documentation,
maintenance of technical records and log books for the flights, responsibility of obtaining the operating certificates,
keeping the aircraft airworthy, such as, the maintenance, engineering and repair of the aircraft, third party liability insurance of the aircraft, etc,
May entail service tax and Value Added Tax
Commercial economics week 5