Playing By the Franchisor’s Rules When Selling Your Store
When selling a franchise, the franchisee is not a free agent. Even if a buyer makes you a great offer, you can’t formally accept it until certain details are worked out with the franchisor. Most franchisors have a right of first refusal, which means that whenever a prospective buyer makes a bona fide offer to purchase the franchisee’s interest in the franchise agreement or business assets, the franchisor has the right to purchase it on the same terms and conditions within a set time period.
Review the franchise agreement to see what rights the franchisor has reserved for itself, any requirements for notice to the franchisor of possible sale, the form of the notification, and how many days the franchisor has to respond.
In other words, the franchisor may end up buying the franchise. Many franchisees have a problem with this provision, and rightfully so. They feel that such a provision hurts or at the very least interferes with their sales efforts.
Consider a sophisticated buyer who spends months checking out the franchise and makes an offer only to lose out on the opportunity to buy the business because the franchisor moves in, matches the price, and buys it right out from under them. That potential buyer will not be pleased. Some sophisticated buyers won’t even begin to negotiate or do their due diligence on the business if the franchisor will likely match their offer.
You should discuss this issue with the franchisor and determine what its intentions are before beginning to market the business. If the franchisor decides that it is not interested in executing on its right of first refusal, get it in writing. Such proof will allay a potential buyer’s fears.
Franchisees also need to deal with the franchisor’s right to approve the transfer. Most franchise agreements give the franchisor the right to approve all transfers of ownership. Think of a prospective groom asking the father of the bride-to-be for permission to marry his daughter before he asks for her hand in marriage. Some provisions add that the franchisor can’t unreasonably withhold consent. The word unreasonable can be open to debate, however. Typically, a new franchisee must meet the franchisor’s qualifications, fulfill ownership requirements, such as training and remodeling, and sign a then-current form of franchise agreement.
The franchisor also receives a transfer fee, usually to cover legal and accounting costs. Not all transfer fees are identical, so confirm the exact transfer fee applicable to your deal before negotiating the purchase price.
For example, instead of charging a flat fee, some franchisors charge a percentage of the then-current franchise fee or even the sales price. Others reduce the fee if the buyer is an existing franchisee or an employee of the franchisor or franchisee. Transfer fees, training costs, and updating costs can be used in negotiations to affect the purchase price and timing of the deal, for either the selling franchisee or the buyer.
Expect the franchisor to ask you to submit the proposed purchase agreement and to take a look at the purchase agreement generally on these points:
- Inconsistencies between purchase agreement and franchise agreement
- Debt structure and leverage
- Overall viability of transaction
- Structure of ownership and operations
- Condition of the facility and arrangements for upgrading or repairs
You will need an attorney involved to assist you in structuring and documenting the sale of your business. The franchisor will also want to confirm a few items that directly impact it, including that
- Monies owed to the franchisor and its affiliates have been paid in full.
- You’ve executed a general release of all claims against the franchisor.
- You’ve agreed in writing to comply with all post-sale obligations under the franchise agreement, including non-compete obligations.
Some franchisors recommend or mandate that the selling franchisee remain onboard for a period of time after the sale to smooth the transition to the buyer. Some franchisors require, subject to state law, the selling franchisee to stay on as guarantor of the buyer’s performance under the franchise agreement.
The need for such conditions and how well they work out may depend on the experience and skill of the buyer and the personality of the selling franchisee. It’s always awkward to be asked to train or monitor your replacement, and the situation can be more so if the buyer changes your tried-and-true methods for operating the business while you’re still training.
On the plus side, in-house mentoring, consulting, or personal introductions to suppliers and customers by the selling franchisee are valuable and should raise the sales price. Buyers may view a willingness to stay on as a reflection of the selling franchisee’s transparency. And the selling franchisee may gain peace of mind if the buyer is a gem, seeing that the business is in good hands.
Some franchisors are reluctant to get involved in the sale, especially regarding the selling price. If the selling price is high, and the franchisor objects, the selling franchisee may claim the franchisor interfered with the sale. On the other hand, if the franchisor doesn’t tell the buyer that the price is excessive, and the buyer (as the new franchisee) is unable to meet the debt service on the business, the buyer may claim the franchisor should not have approved the deal later on. These scenarios can be troubling
Many franchisors have worked out formulas concerning debt service–to–cash flow ratios, which they make available to their franchisees who may sell in the future. Although not guarantees, providing this type of guidance can avoid problems later on. Often if the price is high but the amount of cash the new franchisee is willing to invest keeps the debt service low, this will make an otherwise unacceptable deal acceptable.