An often overlooked (or sometimes minimized) component of pre-purchase due diligence when buying a franchise is the careful examination of the circumstances, restrictions, and conditions under which you will be permitted to sell that franchise at some time in the future.
Most franchise agreements will impose significant hurdles on the resale of a franchise, which may substantially affect your ability to sell or resell your franchise, if and when necessary. As such, it’s important to fully understand the practical and contractual limitations on a free transfer of what may be one of the largest investments that one might make.
Most franchise agreements contain restrictions on transfers and impose certain common restrictions on the sale of your franchise. Chief amongst them are:
- You may not sell to just anyone—the franchisor reserves the right to approve of any purchaser, and in some instances to approve (or decline) the financial terms of your proposed resale. The franchisor may take the position that the purchaser does not have the required financial strength or business experience, or that the proposed sale price is not supportable based upon the performance of the franchise itself.
- An approved purchaser of the franchised business will likely be required to sign the “then-current form” of franchise agreement in use in the system. Ideally, this won’t vary widely from the form of agreement that you will have signed, but the “then-current” form may impose additional or higher fees, further affecting the value of the franchise you are looking to sell.
- You’ll have to pay a transfer fee to the franchisor and may be required to renovate or refurbish the franchise (at your cost) prior to any sale.
- The franchisor’s consent to your proposed sale will almost certainly require that you be in full compliance with the terms of the franchise agreement. If you’re struggling in the operation of your franchise, you will be required to bring the franchise into full compliance, as determined by the franchisor, before you can sell.
- You may be required to give your franchisor the right of first refusal to purchase the franchise before you can sell to a third party. They are typically under no obligation to purchase the franchise, but usually have the option to do so. Be mindful that the formula that they may use to assess the value for such a repurchase may be the asset value, as opposed to the going concern value, or it may simply be based upon the depreciated value of the assets of the franchise—both of which may be significantly lower than the value of the franchise as a going concern.
- You may be restrained from using the system’s marks and logos in advertising the franchised business for sale (this is why you often see listings for “popular pizza franchise” or “established juice franchise” as opposed to seeing particular names, brands, or trademarks). This can limit the number of interested eyes that view your listing.
- The competition for your sale won’t just be from other system franchises being resold or franchises from competing systems but also “new grant” sales from your franchisor. Many purchasers may not be interested in buying existing franchisees, preferring instead to purchase a new franchise (often at a comparable price) with newer equipment, in a location of their choosing, and with a clean slate.
Finally, a little bit of Latin. Nemo dat quod non habet is a legal principle which means (roughly) that “no one can give what they do not have” or alternatively, you can’t sell what you don’t own. When you sign your franchise agreement, the clock starts ticking on the time remaining to operate that franchise. Remember, the grant of a franchise isn’t the perpetual right to operate that business—it is instead a grant from the franchisor to operate a business for a set period of time. As such, the more term you use, the less you have to sell. For instance, a franchisee four years into a five-year initial term may find many buyers wary of purchasing a business with one year remaining on the initial term. You can’t sell what you don’t have—and if you don’t have a sufficient remaining term for a buyer to make back their investment, the value of that dwindling right will diminish substantially.
Buying a franchise can be an exciting stage in your life—but buying a franchise is different than buying any other asset that might be sold relatively easily. While you may not have the intention now of selling the franchise, circumstances may change, and understanding the legal and practical restrictions to any future sale is of vital importance.
Daniel So
Partner
Dale & Lessmann LLP
dso@dalelessmann.com