Considerations for the End of Your Franchise Term
Be careful how you make your decision about what to do when your franchise term is ending. In addition to likely being required to pay a renewal fee, your franchisor will generally want you to bring your business up to its current standards. That might require you to make a substantial additional investment. Don’t assume you will recoup your entire investment if you upgrade the franchise. Work with your accountant and other advisors in making this type of decision.
Sometimes the decision to leave may not be yours. Although you may believe you have the right to enter into a new or continuing franchise agreement, that may not necessarily be true. Your franchisor will, in most situations, also have some choices to make if you have not been a solid franchisee during your existing term, have not been paying your royalties, or have been violating other aspects of your franchise agreement.
If that is the case, your franchisor may not want to extend the relationship with you. In some situations, you may not even have any successor rights, and the choice to continue — of course, subject to the law — may totally be in the franchisor’s hands. However, in a few states there are laws that limit a franchisor’s right to not renew your franchise. Working with a qualified franchise lawyer or consultant is essential in advising you on the impact of these laws.
But in most situations, you may be choosing to leave the franchise system because you want to and not because you have to. Your reasons will vary. If your franchisor’s brand is wildly popular, or your business is wildly successful, selling out while the value of your business is high may offer you a great opportunity.
Or the reasons may be more mundane. Perhaps your spouse or significant other has received a great job offer out of state. Maybe you simply miss your grandkids who live in another state, and selling your business so that you can live closer to your family is the right life choice for you.
Perhaps, even when the business is financially successful, you are simply just tired of it. You have rolled one too many bagels, heard one too many complaints from customers, or butted heads with the franchisor one too many times — and it is just time to do something else. Whatever your reason, ending the franchise relationship does not have to be as ominous as it sounds. It could be a new start for you.
When you signed your franchise agreement, you most likely did not obtain the right to run your franchise indefinitely. Under the franchise agreement, a franchisee obtains the right to use a franchisor’s brand and system for a specific period of time. Depending on the terms of the franchise agreement, the franchisee’s rights to operate under the brand and system may last 5, 10, 15, or even 20 years. The clock usually starts ticking on the day the franchise agreement is signed, but, depending on the franchisor, might begin when the location opens for business.
If the latter is the case, your franchisor gave you additional time to amortize your investment by not counting the time you spent in finding and developing your business prior to its opening. It is not usual, but it can be a great benefit to you as the franchisee at the time.
At the end of the term, you have some choices to make:
- You can leave. If you don’t want to continue running the franchise, you can simply thank the franchisor for the opportunity and move on. You will be giving up the right to operate a business under the franchisor’s brand, and the franchisor may resell the rights in the market to a new franchisee. You likely will be able to sell the building (if you own it) or any equipment or other assets so long as they are not proprietary to the franchise system.
The franchisor may also elect to exercise an option (if granted to the franchisor under the franchise agreement) to assume the leases for the premises and equipment. Or purchase all or certain of the assets of the franchisee’s business at a predetermined valuation or based on an appraised fair market value.
- You can sell. You may choose to sell the business to another person. But remember, your buyer will need to first be approved by the franchisor to operate the franchised business. In addition, the franchisor may require the new franchisee to sign a new franchise agreement, and in some situations, the franchisor may have some say over the amount the new franchisee pays you for your business.
Generally it is to your advantage if the franchisor is willing to grant your buyer a new franchise agreement, because you may have only a few years left on your franchise agreement and a new franchisee will likely pay more for your business if they have a longer period in which to operate it.
On occasion, a franchisor may have a say over the price you set for your business’s assets. If the price paid by the new franchisee concerns the franchisor because it reasonably believes the new franchisee won’t be successful given the amount of debt they will need to service, the franchisor may disallow the sale at that price. If that is the case, your options may include reducing your selling price. In some instances, the franchisor may be satisfied if your buyer simply puts up more cash and reduces the amount of loan they will be carrying.
- You can switch. In some cases you may want to end the franchise relationship, but if you like the business, you may desire to continue to operate a similar business not identified by the franchisor’s brand or system. You might even be considering joining a competing franchise and becoming identified by another franchisor’s brand.
Unfortunately, in the majority of cases, this is not a viable option because typically you will be bound by a non-compete provision prohibiting you from operating the same or substantially similar business at your current location or near any other locations within the franchisor’s system. Moreover, the duration of the non-compete provision generally extends a few years beyond the expiration of the franchise agreement. As noted earlier, the franchisor may elect to exercise its option under the franchise agreement to assume the lease for the premises and/or purchase the assets of the business, subject to the laws in your state.
- You can continue. If you want to continue to operate your franchise for another term, expect some changes. In most cases, in order for you to obtain a successor franchise, you are required to notify the franchisor in writing of your desire to continue (generally the notification period is six months or longer). You will also be required to make an additional investment to bring your business up to the franchisor’s current system standard for new franchisees, and you will be required to sign a new franchise agreement. The terms of that new agreement will likely be different from the terms contained in your existing agreement.
As always, make certain you review the new franchise agreement with a qualified franchise lawyer before you sign on the dotted line.