April 3, 2017
You need an exit strategy. It’s as plain as day, yet most new franchisees never address the idea of leaving their business one day. All the excitement centers on opening and growing. It’s a different, but mandatory, approach to open their franchise unit with the end in mind.
Bar none, the best exit strategy is to sell your business.
You want to sell your business to successfully exit and fully capitalize on all the money you invested into starting and growing this business. Particularly for a brick and mortar franchise, several things you establish when opening your business can outline your success or define your failure when it comes to closing the sale down the line.
If you’re a brick and mortar, location is everything. This will define a large part of your success, both in business and then as you look to exit. Do your research, know the market trends, and find the right venue to launch your business.
The biggest factor in your ability to sell will be defined in your property lease terms. A large majority of your business value is tied into the location and known presence to the community. If you take that away, a buyer might as well purchase a new unit directly from the franchisor.
Maintain your equity through favorable lease terms.
Assuming you have a ten-year franchise term, you should you sign up for a ten-year term with the franchise; I suggest a ten-year lease with two five-year options. Here’s the important part. Your lease must allow for transferring the terms and options to a new franchisee. In my opinion, the inability to transfer your lease to a future buyer kills the deal.
The threat of having to move an existing business is an expensive endeavor that will drive most buyers to leave this deal on the table or request a large discount. If you only have three years left on your lease, and no options for the new owner, that new owner only has three years of running the business before they may have to move or attempt to negotiate new terms with the landlord.
It’s costly and detrimental to the business.
Generally I recommend that franchisees sign a lease term that mirrors the franchise term with options. As you can gather, it’s important to mirror that time frame in your lease and build out options after your first franchise term so you do not have overlap.
Understand that renewing a franchise term comes with additional costs. First, you have the renewal fee. Secondly, the franchise may have adopted new trade dress, internal systems, or other updates that will need to be addressed. For both you and the potential buyer, it’s better to put as much distance between these potentially pricy updates.
For example, if you sign up for a five-year term and renew for an additional five years, you go through the renewal and renovation process twice compared to the buyer in the ten term who only had to do it once. Should the original buyer sell the franchise in year seven, they won’t even go through that process. The new buyer will need to address renewal in three years.
The other side can be true as well. If you are entering year nine of a ten year lease with the intent to sell the business, but no buyer on the horizon, I advise that you renew the franchise agreement and exercise your options to preserve the good will and value you have created. Otherwise you lose all the goodwill and investment you’ve built into your business. Once you close your doors, a new franchisee can open in the same spot and build on your legacy without you being compensated.
Due to the nature of the franchising industry, it’s likely that the franchisor will need to sign off on the new buyer. The terms for a transfer will all be spelled out in the FDD, which may include the new franchisee meeting the current requirements and acquiring all the necessary training.
Most FDD’s give the franchisor the first right of refusal. While it’s always an option, I rarely see franchisors purchase operating units. After all, they are in the business of selling, not buying.
The last component you need to consider from the FDD is the transfer fee. Typically, the current franchisee and the new buyer determine who will pay it or how the fee will be split as part of the negotiation process.
One crucial component to purchasing a franchise unit is partnering with an experienced franchise lawyer to help establish a strong legal foundation. You want to ensure you understand exactly what you are signing up for, identify red flags in the FDD, and get your franchise career off to a good start.
Contact me today to ensure you are starting your new business on the best legal footing.