When Valuation Eats Values for Breakfast: A True Story

Photo credit: fineartamerica.com

The birth of every new unicorn is a celebration. It’s a testimony to the entrepreneurship and enterprise of the nation, and of the opportunity that the country offers for investors. The founders are celebrities in a world where entrepreneurship is the new tinsel town. The investors are lauded for their acumen to spot talent and opportunity. But between the founders, investors and delighted customers are a forgotten group — the channel partners or service providers. Call them drivers, property owners, vendors, suppliers or franchisees. In a mad rush for valuation, they are often taken for a ride. In this article, the Author shares a true story of a franchisee of one of India’s latest unicorns. How many such untold stories are out there, the Author wonders.

The newly appointed Chief Revenue Officer (CRO) of this unicorn appeared as a beacon of hope to the Franchisee. “I know that we have major trust issues with the franchisees, and I am here to correct it,” he said over phone. He was speaking what the Franchisee had hoped to hear for about four years since she had invested over INR 35 Lakhs (~USD 50,000) of her own and her husband’s personal savings in a retail franchise of this upcoming start-up.

At the time, the 6 year old start-up, which had become visible as an online player, had just ventured into omni-channel model through retail franchising. The Company was delighting customers with value products, and the business proposition looked attractive. She herself was a customer of one of the early franchisees, and was impressed by their service. Little did she know what was in store when she made the investment.

Things were pretty good initially. As a woman entrepreneur she was a favorite of the start-up. She was picked as a brand ambassador for the franchising business. Her pictures and testimonials were taken to promote the franchise. Her business got awards of best new franchisee and best NPS within months of start. The business also started reasonably well. Seemed like she would achieve break-even as expected.

Within a few months the true picture started to emerge. Things were not as rosy as they looked. Under pressure of mounting losses, the franchisor started by cutting previously committed local marketing support, and now started charging for the support provided. Unauthorised and unilateral deductions were made from margins. Payments due were inordinately delayed — by months and years, not just days. Even when they came, they were not fully paid. Pressures were being mounted to make more investments in the franchise in various forms. Why, the franchisor even claimed money towards “account reconciliation” to cover up inability to match accounting entries at their end. There was no response from the franchisor to resolving the issues. The escalation process was dysfunctional.

She was not the only one affected. Many franchisees were stuck with heavy investments, and had no option but to continue bearing the brunt of unethical and unlawful business practices. The stacks were in favor of the franchisor because of a heavily one-sided contract. Even if franchisees had sufficient reasons to go for litigation, they will have to go to the franchisor’s city to file the case because of the jurisdiction clause in the Agreement (for her this was 2200 km away). And if a franchisee just wanted to exit, there was a clause that did not allow doing the same business for one year. What would they do with all the assets?

The franchisee business was a trap — you can enter, but you can’t exit. Just like Abhimanyu’s chakravyuh in Indian mythology.

Meanwhile, the Company was growing fast, and got further rounds of funding. A round of funding about three years back was got the company to pivot to an omni-channel model. They were now setting up Company Owned Company Operated (COCO) stores. The Company targeted top cities for COCO stores and forcibly acquired top-performing franchisees at paltry sums. This was a shrewd move to reduce investment in an otherwise capital-heavy retail business.

Early franchisees who were signed on at higher margins, were also systematically eliminated to replace them either with COCO stores, or with new franchisees who were now signing up at lower margins. These were also clever moves to improve margins and to make COCO stores viable from Day 1 with a ready business the franchisee painstakingly built.

Even those that were forced to exit were not getting their final settlements. To add to their plight, they were harassed with legal notices if they continued to be in the same business. Owing to the difficulty and cost of doing litigation in a distant city, the franchisee would usually settle, incurring more losses or writing off dues. Using these stories, Company personnel would now intimidate franchisees and “show them their place”.

While the franchisees suffered, the Company’s valuations continued to sky-rocket. With the latest round of investment by a global PE Firm, the Company had joined the unicorn club in 2019. In the last four years the Company transformed from an upcoming start-up to an arrogant unicorn that believed it was above law.

But the Founder-CEO, who called himself the Chief Customer Happiness Officer, was now the new poster-boy of the start-up ecosystem. He had the perfect profile of a visionary founder: engineer, educated at a top Indian B-School, US-returned techie and in his mid-30s. And he was backed by some of the most reputed angel investors, venture capitalists and global PE firms. For them, could do no wrong.

Soon the franchisee in our story was no longer their favorite. Because she asked questions. About why she was not paid the receivables that were due for more than three years. About why unauthorized deductions were being made. On why she had to take up disproportionate share of marketing spends from which COCO stores and e-commerce business benefited. On why products that were sold online and in her competing COCO stores were not available in hers. About why the COCO Stores were operating close to her store, weaning her customers away. About why her customers should be denied offers that were being given away at COCO stores. About why she should be forced to migrate to a new business model that made it even more one-sided in favor of the Franchisor. Now all support was being cut off for her as she refused to sign a new Agreement to migrate to the new model. For every operational issue she now raised, the reply was the same — “sign the new agreement, and we will address the issue.” To top it, COCO stores were aggressively targeting her customers making her business run deeper into the red. She wrote to the Founder hoping for solutions.

She was wading into dangerous waters. This was break or make. She could either get the issues resolved fully, or get thrown out. She knew that the franchisor was not happy with her as they had managed to arm-twist all other franchisees to sign the new contract. Stories were afloat that a few who had not signed were abruptly terminated. She had also got an email from the franchisor stating that if she did not sign the new contract, her franchise would be terminated.

At the time, she had reached out to a member of the Board who got her a temporary reprieve. She had considered reaching out to him again. She decided to try her best with the CEO before escalating again to the member of the Board in case it did not work.

She had signed a “Standard Franchisee Agreement” in good faith four years back without realising it had many restrictive clauses that could come back to bite her now. That was her first mistake. She regretted it. So, signing the new contract was not an option. She had to get the franchisor’s support for at least the rest of 1.5 years of the contract period for any hope to recover her investments. By this time her investment in the franchise had crossed INR 65 Lakhs (~USD 90000) with accumulated losses and money due from the franchisor. This was without her drawing any salary for herself in this period. She had to take a chance now. The Founder was her hope.

The Founder took offense. He echoed the same message — sign the new contract and then we will talk. He did not appreciate that his decisions “in the larger interest of the company” were being questioned by a measly franchisee. We only want to work with ‘progressive franchisees’, he said.

The same franchisee, who saw the spark in him and his unproven business model a few years back, was no longer “progressive”. The Franchisee, who continued to support the Company through her efforts and savings to fund losses while the founders minted their millions, was now being questioned for commitment. She was determined not to make the mistake of signing an agreement on trust a second time knowing well that the other Party was not ethical and trustworthy. The Founder replied, offering to “take over” the store if she “had problems” with the way they operated.

It was a not really an offer. It was a threat. “Fall in line, or we will push you out,” was his message. She realised she was up against a bully, yet she was not prepared to give in.

That is when the kind CRO comes into the picture.

“I don’t want yet another franchisee to go out of our system with a trust issue” said the kind CRO, after the Franchisee explained her history of issues and proposed that the Store be taken over at a fair value by the Company. She only wanted her investments and losses recovered. With her Store being sandwiched between 3 COCO Stores that were actively taking away her customers, she had lost any hopes of returns from the investment.

“I have understood your issues. Let me work with my team to prepare a revival plan for you. Give me 3 months. I will personally work with you to turnaround the store and to address your issues before we discuss about your signing the new contract,” said the kind CRO giving her hope. He was quite senior compared to the young and hot-blooded Founder, and experienced as the CEO of an MNC. And he was speaking a very different language from what was generally a culture of abuse and fear-mongering the Franchisor and its employees exhibited. “Give me time till Thursday to send you the revival plan,” said the CRO. Perhaps things would change under his leadership, and she would not have to reach out to the Board member after all, she thought.

On Thursday evening, she received an email as promised by the kind CRO. It was from a law firm, and titled “Termination Notice”.

That’s when valuation ate values for breakfast.

Santosh Sreedhar is a Partner with Avalon Consulting, a leading Asia-focused Strategy and Management Consulting firm. He can be reached on santosh.sreedhar@consultavalon.com

Views are personal.

This article was originally published on linkedin.com.

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Management professional with over 20 years’ experience in strategy consulting and FMCG (CPG) marketing & sales across Asia and East Africa.

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Santosh Sreedhar

Santosh Sreedhar

Management professional with over 20 years’ experience in strategy consulting and FMCG (CPG) marketing & sales across Asia and East Africa.

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