The franchise industry is a massive contributor to the Canadian economy, with more than 1,100 franchisors and some 67,000 units across the country. As the 12th largest economic sector in Canada, franchising is predicted to grow an additional 4% by 2026.
It’s no wonder savvy investors and business owners are interested in purchasing existing franchise units to grow their portfolios and incomes. In addition to having a proven record of sales and dedicated market share, those purchasing an existing franchise unit don’t need to account for a ramp-up period. You can make sales projections using historical numbers rather than best guesses.
While buying an existing franchise does come with advantages, it’s vital for investors and business owners to manage their risk by carefully reviewing the financial and tax implications before signing on the dotted line.
Understand asset vs. share purchase tax implications
Knowing the difference between an asset and a share purchase is vital, as the type of purchase you make will have direct impact on your finances, taxes, and legal risk.
With an asset purchase, you buy specific assets, such as equipment and inventory, and assume fewer liabilities, debts, taxes, and lawsuits. In a business sense, this is a fresh start with significant risk protection. This structure is preferable for many buyers because of the ability to depreciate assets that are being purchased over time (capital cost allowance) and a reduced risk of inheriting any liabilities from the previous owner.
With a share purchase, you acquire the entire franchisee corporation, which includes the assets, liabilities, and tax attributes. This structure is preferred by franchise sellers because of their potential access to the lifetime capital gains exemption on the sale of shares of a qualified small business corporation (QSBC).
When negotiating your sale structure, consider your risk tolerance, potential tax savings, and business continuity needs.
Review historical financials and tax compliance
Carefully examine financial statements from the last three years. Keep in mind that many franchisees may not have an audit or review engagement during this period, so it is your responsibility to assess if you can rely on the information provided, and to request additional information as necessary.
Pay attention to revenue trends, expense anomalies, and seasonality. Assess profitability and determine if you will be able to recoup your investment in a reasonable time frame.
If you’re conducting a share purchase, it’s vital to do your due diligence on tax compliance. Confirm the Canada Revenue Agency (CRA) filings for GST/HST, payroll, and corporate tax are up to date. Consider whether there are any outstanding tax liabilities or audits, and whether the proper remittance of franchise fees and royalties have been made.
Evaluate working capital and cash flow
Assess whether the unit generates sufficient cash to cover debt service and working capital needs. You can do this by reviewing historical cash flow statements and preparing projections post-acquisition.
Be sure to consider your own cash flow requirements during the first months of the business. If the business will be your full-time job, for example, determine whether you’ll have enough cash flow to cover your personal expenses.
Don’t forget about any significant costs the business may need to incur in the next few years. For example, many restaurant franchises are required to undergo a design refresh at specific intervals. Or if you’ve entered into a loan agreement, you may need to meet specific ratios as part of the lending agreement.
Consider transition and setup costs
Regardless of whether you have an asset or share purchase, you’ll need to determine transition costs, which can include legal and professional fees, training seminars, and inventory valuation. If you have existing businesses, it’s important to transition accounting systems so they are consistent across the board.
In a share purchase, consider if you or the seller will be responsible for the termination of any employees. If you exit an employee after the transition, you may be responsible for the cost of their severance. In an asset purchase, you will need to rehire the franchise employees and may need to renegotiate contracts, which could include additional costs.
The importance of financial and tax due diligence cannot be understated. By considering these implications, you’ll be better equipped to prepare accurate financial projections without any surprises.
Work with a franchise-savvy accountant and legal advisor who can support your business venture, help mitigate risks that could threaten your franchise, and work with you to build a plan for long-term growth.
Lyn Little
Partner, National Franchise Industry Leader
BDO
llittle@bdo.ca