follow us on twitter @EliteFranchise find us on facebook connect with us on linkedin google+ page

Win-win: the sale of an existing franchise can benefit all parties

on Tuesday, 06 May 2014. Posted in Legal

Whether it’s the decision of the franchisor or franchisee, a franchise resale is a common occurrence in the world of franchising. Kate Legg, associate at Higgs & Sons, talks us through the ins and outs

Win-win: the sale of an existing franchise can benefit all parties

You’re a successful franchisee and you’ve been running your business profitably for several years. You’ve put a solid team in place and you have a loyal customer base. The kids have flown the nest. You’ve carefully squirreled away some of your cash for the future. Now it’s time to take things easy and start enjoying life. For whatever reason, life has moved on and growing the business is no longer your priority.

Or perhaps you’re the franchisor. Your franchisee has gotten a bit too comfortable. He is happy with the income he makes and quite content to let the business tick along nicely. He doesn’t want to invest the time and effort into growing the business any more, so he takes his foot off the gas and lets the business just coast along. As a franchisor, this is less than ideal; it may be time to start thinking about replacing the franchisee with someone with more drive and a desire to continue to grow the business.

Whether you’re a franchisee or franchisor, there will come a point when it’s time to part company. Most franchise agreements will be for a fixed term with no option for the parties to terminate by giving notice. This means that the best option when the time comes to exit is likely to be to sell the franchisee’s business on to another franchisee.

A franchise resale can offer many benefits to all parties. For the exiting franchisee, there is an opportunity to realise a capital value. Selling the franchise to another franchisee as a going concern is likely to be the best way to maximise the sale value of the business.

From the franchisor’s perspective, offering the opportunity for resale can help in the recruitment process. A network is going to be more attractive to a potential franchisee if there is the ability to make an income during the term of the franchise agreement and the option to generate a capital sum on sale of the business.

The franchisor may also use the prospect of a resale to help motivate franchisees who may have become stuck in a rut. If the franchisee understands that he would like to achieve a certain price on sale of his business, he can work towards ensuring that the turnover, profit margins and other key performance data are sufficient to support the desired price. The franchisor will have a key role in managing the franchisee’s expectations.

It’s not just the franchisor and exiting franchisee that benefit from a resale. There are advantages for the incoming franchisee to buy a resale rather than starting from scratch in a new territory. For starters, the new franchisee will be taking over a going concern which will be generating sales and income from day one. In contrast, it may take several months before a new business is ready to launch and is making its first sales and even longer still before the cash starts to roll in.

In addition, there will be greater certainty if a franchisee buys a resale. Ordinarily, a new franchisee will prepare a business plan based on his estimates of the sales he expects to make and costs he expects to incur in the business. In a resale, the franchisee will be able to base his figures on the previous track record for that business, knowing the actual sales and profit figures in the previous years and months. 

Of course, there is no guarantee that all of the existing customers will remain with the business if the current owner moves on. The success of the franchise will still depend on the efforts and abilities of the new franchisee, but the franchisee will at least have some actual data to base his estimates on rather than making an educated guess.

 

Types of sale

If the outgoing franchisee operates through a limited company, there will be a choice of whether to sell the assets of the business or to sell the shares of the franchisee company. Historically, many franchisors would only permit an asset sale; however because they are often advantageous from a tax perspective, share sales are becoming more common.

Put simply, if the assets are sold, the buyer will form a new company and the existing stock, furniture, fittings, equipment, contracts, employees and any rights to occupy premises will all be transferred into the new company. The outgoing franchisee will retain any liabilities incurred up to the date of the handover from buyer to seller.

In a share sale, all of the assets, equipment, contracts and employees remain in the original company but the owner of the company changes. This means that in the case of a share sale, the buyer takes the company “warts and all” and will inherit any historic liabilities as well as the assets.

There are many factors which will influence the choice of asset sale or share sale. Professional advice should always be taken from an accountant and a lawyer before the final decision is made. It is also worth discussing this with the franchisor who may have their own policies on whether share sales are permitted in the network.

 

Process of sale

Whether a share sale or an asset sale is chosen, the first step will always be to consult the franchise agreement and franchisor. Most franchise agreements will set out a procedure for resales which will include giving the franchisor the right to approve the potential buyer; and a right of first refusal for the franchisor to buy back the business itself.

Once a buyer has been found who is acceptable to the franchisor, the process of sale will comprise the following steps.

 

1 Agree basic terms

The buyer and seller will need to agree the basic terms of the deal. These will include:

• How much is the buyer paying?

• What is included in the basic price and will the buyer be paying for any 

extras – for example is stock included in the price, or will stock be 

subject to a valuation at completion?

• When is the price payable? For example, is the whole amount payable 

when the sale completes, or is part of the price payable at a later date?

• When are the parties aiming to complete?

• Is the seller required to provide any post-handover assistance?

• Are there any special requirements from either party?

 

2 Pre-contract enquiries

Once the basic terms have been agreed, the buyer’s solicitor will raise pre-contract enquiries. This is where the buyer seeks to learn as much as he can about the business and to identify any potential issues at an early stage. It is likely that the seller will be expected to confirm in the sale agreement that the information he gives in response to the replies is accurate, so it is important that the seller takes time to answer the replies fully and accurately.

 

3 Negotiation of the sale agreement

In most established networks, the franchisor will have a standard sale agreement which will form the basis of negotiations. The buyer’s solicitor and seller’s solicitor will then agree any changes to the standard document to reflect the details of the specific deal. Once the agreement has been agreed between the buyer’s solicitor and the seller’s solicitor, the franchisor will usually want to approve the final form document.

 

4 Exchange of contracts

Exchange of contracts is the point at which the buyer and seller become legally obliged to proceed with the sale and purchase. Until then, either party could change their mind and walk away from the deal. Once contracts are exchanged, the deal has been agreed and becomes legally binding and neither side will be able to change the terms. However, at that point, the franchise still belongs to the seller and the seller will continue to own and operate it.

 

5 Completion

Completion is the legal transfer of the franchise. From then on, the buyer will own and be responsible for the business. In sales of non-franchise businesses, it is normal for exchange and completion to happen at the same time. However, in a franchise resale, the franchisor may insist that contracts are exchanged. There will then be a gap whilst the buyer attends the franchisor’s initial training course. Completion of the sale of the business then takes place once the buyer has completed the initial training.

When handled well, a resale is the ultimate win-win-win for all parties. The franchisor is able to inject new life into the network; the exiting franchisee realises a capital value; and the incoming franchisee hits the ground running with an existing customer base and sales from day one. However, a badly run process can result in delays in completion and unnecessary expense on all sides. It is therefore vital that expert advisors with relevant experience are engaged from the outset. 

Kate Legg is an associate at Higgs & Sons, the law firm

Affiliate Member

Strategic Media Partners

<