January 3, 2017
Purchasing an existing franchise helps reduce risk. Rather than vetting a franchise with the hope that it thrives in your specific region, the current operator has already proven the model in the region. It’s running, operating, and hopefully making substantial profits.
Whenever you purchase an existing business, franchise, or other, there are many moving pieces to the transaction.
Purchasing the shares or membership interests of an existing franchise leaves your new business liable. Instead, I help buyers put together asset purchase agreements. This means the prior business entity will not be acquired and you will form a new entity to purchase all of the assets, which may include, machinery, client base, good will, and operations of the business without the risk of problems from the previous owner, such as a creditor or lawsuit catching you from behind.
To execute the purchase, we open up an escrow account and establish a bulk sale transfer agreement. We notify all potential creditors to let them know to either come forward or forever hold their peace, so to speak.
A large bulk of every business purchase is spent finalizing terms and price. One of the pieces unique to a franchise purchase is the transfer fee required by the franchisor. As part of the negotiation, it’s decided whether one party will pay the fee or split it between the two.
After determining the sale price, the next hurdle boils down to financing and payment terms. Financing options take many different shapes, depending on what the new buyer can bring to the table or can qualify for. Franchisees typically utilize either a SBA loan or pull from part of their 401k. While more risky if you are the seller of a business, I have seen agreements where the current owner finances the sale of the unit. For example, the purchase price was $300k, with $150k upfront and $150k to be paid over time.
It’s exceptionally important to have your advisors help you through this process to ensure that everything is in order and the terms are done correctly.
For franchise that requires a brick-and-mortar location, the lease weighs in as a valuable asset in the sale price. There’s little advantage purchasing a business proven successful in one location to have to turn around and pick up roots after you take over. You may lose a substantial amount of good will from the current location, along with having to spend new tenant improvement dollars at a new location.
I always stress the importance of current or new franchisees to secure transferable renewable options in their leases. Reviewing your ability to exercise options on the lease plays an important role in the vetting process. Many times, leases state that options to renew are personable to the tenant and can not be transferred when the lease assigned. In some instances if the tenant seeks to assign or sublease the space to a new buyer, the lease may state the lease can be canceled. This is what I would call a “deal killer.” Under these situations the value of your business could be severely impacted.
The other aspect of the lease that will need to be addressed is the personal liability. It’s common for the existing owner to have signed the current lease under an LLC or corporation but be required to execute a personal guarantee. They will want to negotiate with the landlord to either get out of that liability or put a dollar cap on liablity.
As mentioned, you will establish a new entity for the franchise once you complete the transaction. Depending on your unique position, I typically advise new owners to set up either a LLC or S-Corp. If you used 401k funds, you will have to establish a C-Corp in accordance with the Employee Retirement Income Security Act (ERISA).
Particularly when purchasing an operating franchise unit, it’s important to partner with a lawyer who specializes in franchise law. As both a co-franchise owner and an experienced franchise lawyer, I can help you navigate the entire process. Together we will protect your investment and develop a strong legal foundation to build your business on.