Franchisors in California Face New Realities

There’s a lot to love about California. The state serves as a technology hub for international companies like Apple and Google. It boasts the eighth-largest economy in the world ($2.2 trillion in gross state goods and services). California is also important to just about every brand out there—in total, franchise businesses alone are responsible for $94 billion in economic output.

But there’s a dark side to the Golden State, too. For the past 11 years, California has been ranked the worst place to do business by chief executives. And while the state has long been an important territory for brands to gain traction in, companies like Checkers* & Rally’s, Pita Pit and Christian Brothers Automotive sometimes find that its tough business environment makes establishing a strong foothold a challenge.

So what potentially can hold brands back from quick success? 1851 Franchise took a look at some of the challenges facing business owners in California.

Long Wait Times for Building Permits

Andrew Puzder, chief executive of California-based CKE Restaurants—which operates 3,000 eateries nationwide—called his company’s home state “the most business-unfriendly state we operate in.” CKE, which runs Hardee’s and Carl’s Jr., has stopped opening restaurants in California, where the process of securing a building permit can take up to eight months—four times as long as it takes in Texas and twice as long as in Siberia, Russia.

Puzder told the Wall Street Journal that as permits are being prepared, the lots sit empty, doing nothing but costing the prospective business owner money. In the end, that all effectively adds to the final cost of opening a business.

Overtime Pay Regulations

Throughout many franchise businesses, managers often perform non-managerial tasks at their restaurants, such as helping out during a lunch rush or prepare food when a cook doesn’t show up. And oftentimes, those managers are rewarded for their efforts with a performance-based bonus.

In California, however, managers are allowed to work only 50% of their time on non-managerial tasks. This law is intended to ensure companies aren’t exploiting workers by classifying them as salaried and exempt from overtime pay. According to Puzder, this leads to disgruntled employees hiring attorneys to file class-action lawsuits against companies, claiming the manager worked more than half their time on non-managerial tasks. To date, CKE Restaurants has spent $20 million on these California lawsuits in the past eight years.

California also legally requires an eight-hour work day, as opposed to a 40-hour work week. This offers less flexibility on overtime, and it means there isn’t an option of allowing managers to work more on one day and less on another without pay overtime and cutting into the company’s profits.

Business-Unfriendly Tax Climate

California is in a pretty bad place when it comes to tax climate for businesses. The state ranks as the 48^th worst in the country, according to the Tax Foundation’s 2015 State Business Tax Climate Index. It’s familiar territory, too—the state has occupied the same position for four consecutive years. Currently, California has a 10.9% unemployment rate—third highest in the U.S. And many believe that the high state taxes are to blame (it’s currently the highest in the nation at 13.3%).

“It’s little wonder that most businesses won’t expand in California because of high taxes and burdensome regulations,” Chief Executive magazine reported. “Each year, the evidence that businesses are leaving California or avoid locations there because of the high costs of doing business due to excessive state taxes, grows.”

California Senate Bill 610

Commonly known as the fair franchising act, this bill stemmed from a dispute between McDonald’s and a franchisee. Kathryn Slater-Carter and her husband, Ed, had operated two McDonald’s locations in Daly City, California since 1983. In 2011, corporate headquarters notified them that the franchise agreement for their unit in the Serramonte Center mall would not be renewed upon its expiration in 2014, but that the company would continue to lease, enabling Slater-Carter to sell the unit to another franchisee and recoup some equity.

But in February 2014, McDonald’s decided not to renew the lease, meaning Slater-Carter couldn’t sell the business. After 30 years running the franchise, she would walk away with no payday. Slater-Carter’s experience led her to hire a lawyer, who testified in favor of SB 610. The bill essentially establishes grounds for franchisees to unilaterally change terms and conditions of franchise contracts in certain areas—such as product pricing, store hours, vendor purchases, operating standards, territories, renewals and transfers.

The bill passed the state assembly and state senate and was ultimately shelved for the time being, but it still managed to set off a public battle. In particular, the IFA opposed the legislation, claiming the enactment will lead to unintended consequences that weaken franchisees’ equity in their businesses, damage brands, reduce product quality, limit franchisor assistance, increase incentives for litigation and jeopardize constitutionally guaranteed contract rights.

“SB 610’s one-size-fits-all regulation damages the brand, hurts our small franchise businesses and could cost California jobs,” the IFA said. “This bill could put more small businesses at risk of shutting their doors and severely limit further brand expansion in the state.”

California Franchise Owners Struggle More Than in Rest of Nation

According to a recent study by the Service Employees International Union, franchise owners in California have a harder time staying current on their loans than the rest of the nation. Nearly 30% of Small Business Association loans have failed in the past four years in California—a higher rate than the national average.

“This new report shows that small business owners of franchise outlets in California are facing extreme financial duress. Nearly 71% of California franchisees operate at a loss or are just breaking even,” the study reported.