Last Updated: October-31-2014
10 Legal Tips For Buying a Franchise Resale
Below are just a few to consider:
1. Read the Franchise Agreement/ Franchise Disclosure Document. You will be as obligated to your franchise agreement as the previous owner was to theirs. You should take the time to read and understand your rights, duties, and obligations as a franchise owner.
2. Make sure the franchisor approves of the transfer. If the franchisor does not approve of the transfer then the entire transaction could be cancelled, leaving you in a much worse position that when you started.
3. Have a valuation of the business performed. When you purchase any business, you should make sure to know and understand the actual value of the business. This many times is different than the asking price and can give you some room for negotiations.
4. Determine why the existing owner is selling. You do not want to buy a business on its way down the drain or one where its location is about to be terrible due to changes in traffic patterns. You should always ask why the franchisee is selling. Many times the owner wants out of the business due to retirement or personal reasons, but find out why.
5. Obtain and review financial statements. Purchasing a business that is not profitable is not a smart move. Request at least the last 3 years financial statements from the seller and review them with your CPA to determine profitability and to look for trends.
6. Talk to other franchisees and the franchisor about the seller. Learn about the seller and the reputation he/she has and the reputation that the actual business has in the system. If you are buying in to business with a bad reputation then you could have an uphill battle fixing it with your fellow franchisees and the franchisor.
7. Pay the transfer fee. Most franchisors require that a transfer fee be paid to them to cover their costs in evaluating the transfer and you, as the buyer. Either you or the seller must make sure this fee is paid.
8. Analyze the franchisor. Once you purchase the franchise, you will become a franchisee and subject to the rules and responsibilities imposed by the franchisor. Just like the seller did initially, you should conduct your own investigation of the franchisor.
9. How long is your term. When you purchase the franchise, are you purchasing the remaining years in the term or are you purchasing a new term?
10. Have a franchise attorney review the agreements. Purchasing a franchise, even an existing one, involves various areas of law that many attorneys not familiar with franchise law may miss or may deem absurd. Have a franchise attorney draft and review all the franchise agreement and purchase agreements before you sign.
These are just a few of the tips that go along with buying an existing franchise. For more information, contact Shelton & Power franchise law firm by phone at 866-993-7262 or by email at franchising@SheltonPower.com.
The material contained herein is provided for informational purposes only and is not intended to constitute legal advice. The quality, timeliness, accuracy or completeness of any information herein is provided “as is” without representation, warranty or condition of any kind. All liability in respect of such information is disclaimed. Do not rely upon the information or apply it to your situation without first consulting an attorney.
Franchise resale legal advice
Whether you are buying a new franchise or an existing franchise for sale i.e. a franchise resale, it is essential that you seek legal advice from an attorney who specializes in franchising BEFORE making any commitment to buying the business.
Although the existing franchisee (the seller) has a current franchise agreement with the franchisor…the new franchisee (the buyer) will be required to sign a new franchise agreement per the franchisor. In some instances it is possible to be “assigned” the balance of the initial agreement…but is more likely if you buy a franchise resale that you will be required to sign a new current franchise agreement. Even if you do not engage a legal professional that specializes in franchising for the entire transaction, it is imperative that you have a franchise specialist review the franchise agreement. Any franchise agreement is likely locking you in for a 10 year minimum! It is worth the additional legal cost to bring in an expert; the money you spend on expert advice could be one of the best investments you make.
In this section we will look at the legal advice you need to seek when buying and selling a franchise. We cover FAQ’s regarding the Franchise Disclosure Document and franchise agreement….and why it is important that you have a franchise attorney look over both.
Legal advice for buying a franchise resale
Due to the complex nature of franchising, you should always seek assistance from a franchise attorney when looking to buy a franchise resale.
Franchisees can wrongly think that because they are buying an existing business then they do not need to use an attorney as the current franchisee did and all was ok. It may be the case that they did use one, but has anything changed since then? And alternatively they may not have used an attorney at all.
Though most agreements favor the franchisor you still need to know what is in them and what you are signing. It is therefore vital that you use the services of an attorney who specializes in franchising. No matter how good they are, it is pointless using an attorney who doesn't know about franchising as they will not be able to identify areas of concern etc as they have no experience in this field.
It is essential that you understand all aspects of the documents you sign as without knowing it will only result in conflict or misunderstandings in the future. By an attorney explaining the document to you, you will become comfortable in what you are signing and will know your obligations as well as those of the franchisor.
A large number of the franchisees who fail, do so because they didn't us a franchise attorney. The most cited reasons for this are:
- Too expensive — even though someone may put their life savings into buying a business, it is hard to comprehend that they will cut corners when it comes to seeking legal advice, but they do! They feel that they have spent enough money and if there is a way to save money then they will do it, which usually means dumping the attorney! This is one area however where you cannot afford to cut corners.
- Large franchise network — because a franchise has lots of franchisees, it doesn't necessarily mean that they have all used an attorney and the agreements are all ok and you don't have to. If not an ethical franchise they may all have been discouraged from seeking legal advice.
- Looks straightforward — unless you are a franchise attorney yourself, then you reading a document and saying it is all straightforward, does not count as proper legal advice!
- Unable to change the agreement — some franchisees decide that it is pointless using an attorney as they are unable to change the agreement anyway. The point of the attorney is to make you comfortable in what you signing, which means understanding all aspects of the agreement. You will know what you are getting into before signing, and not afterwards when it is too late!
- Franchisor's word — if a franchisor tells you that the business is so wonderful that you do not need an attorney, then run for the hills! You should ALWAYS use an attorney, and an ethical franchisor will always encourage this.
- Not enough time — a franchisor should allow you sufficient time to look at the business and should never rush you into signing anything. If you are asked to sign off or else they will give the territory to someone else, then walk away. Never feel pressurized into signing anything. This is a big decision you are making and you should be allowed to make it in your own time.
Buying a franchise is a big investment and so to make sure that you are not throwing your money down the drain, you need to use a franchise attorney. They might be expensive but will save you a lot of money in the long run.
What is the Franchise Disclosure Document (FDD)?
The Franchise Disclosure Document (FDD) was previously called the UFOC, or Uniform Franchise Offering Circular. This document gives a thorough description of a franchise’s history, the nature and extent of its products or services, the fees charged by the franchisor, the operational requirements, and the financial calculations involving prior sales, real estate, and profit objectives.
The FDD should also state that past success does not guarantee future success, nor can the FDD make promises as to future profits or revenues. It should, however, provide a detailed account of the business up to date.
The FDD is required by the industry’s “FRANCHISE RULE,” and must include a number of disclosures pursuant to the Code of Federal Regulations, Volume 16, Part 436. The Franchise Rule Compliance Guide can be found at www.ftc.gov/bcp/edu/pubs/business/franchise/bus70.pdf
In most states it is also illegal to offer or sell a franchise until the franchisor has registered the FDD with the appropriate state agencies.
What is the franchise agreement?
The franchise agreement is a legally binding contract between the franchisor and the franchisee. Signing the agreement allows both parties to do business together.
The purpose of the franchise agreement is to outline the obligations of both the franchisee and franchisor. The agreement is standard to all franchisees in the network. By having all franchisees sign the same document, the franchisor is ensuring consistency throughout their network.
The purpose of the franchise agreement is to:
- Detail all duties and obligations of the franchisor and the franchisee
- State the grounds of termination and the consequences
- Outline the payment of the franchisee fees
What the franchise agreement covers
Though the franchise agreement varies depends on the nature of the business, there are key areas that they will all with cover. The agreement should cover:
- Obligations of the franchisor
- Obligations of the franchise owner
- The right to renew
- Training and support
- Fees and payment
- Sale of the business
- Death or incapacity of the franchise owner
A franchisor should promise the franchisee the following:
- To train the franchisee and their staff
- To supply goods and/or services
- To be responsible for marketing the franchise company
- To assist the franchisee in finding property, fitting it out and converting into a franchised outlet (if a mobile business, the franchisor will help the franchisee to acquire a vehicle and fit it out)
- To help the franchisee set up in business
- To improve and develop the business system
- To provide systems such as management and accounting, if required
Is the franchise agreement for a resale negotiable?
Before signing a transfer, a buyer of a resale will want to know which aspects of an agreement made between the franchisor and the franchisee seller are negotiable upon re-sale. This means the buyer must first understand what components of an agreement are non-negotiable. Once the buyer has a good understanding of this, the next step is to become educated on the situational and market circumstances of the re-sale. This information will be leveraged during negotiations, and is where due diligence results in obtaining the best deal.
What are the components or terms of a franchise agreement? There are many, and some are brand-specific. Nevertheless, most can be placed in general categories, and only a small number are needed to turn a potential buyer into an educated negotiator.
The terms that are non-negotiable include:
- The length of the franchise agreement
- The logos, trademarks, and brand issues
- Basic ingredients, brand-specific supplies, and operating processes
- First Right of Refusal
- Right of Approval
The length of the franchise agreement
Of course, no franchise agreement lasts forever. After an agreed upon term of years that the seller has established with the franchisor the agreement does have an expiration date. A buyer needs to know what this is, and if only a few years remain on the agreement being transferred, the buyer will want to learn what the renewal fee will be whenever the agreement expires. However, the length of the original agreement is usually set by the franchisor and is not up for negotiation.
The logos, trademarks, and brand issues
A business becomes a franchise enterprise because of prior success. This success is attached to the brand image, including the logos, colors, trademarks, or even the sayings made by employees. Any issues related to brand or image are non-negotiable, regardless of potential savings.
The basic ingredients, brand supplies, and operating processes
This is true for the basic recipes, ingredients, and frequently the supplies and equipment provided for the franchisee. Although franchisors usually invite helpful suggestions on how to improve products or services, most franchisors do not change their proven, standardized methods of operation just because a franchisee requests adjustments. Even if slight alterations would mean big savings for the buyer, they are usually non-negotiable.
The First Right of Refusal
If the buyer becomes a seller sometime in the future, it is good to know ahead of time that the franchisor has the First Right of Refusal. This means that if the franchisee sets up a buyer for a re-sale the franchisor can refuse a deal between the seller and buyer and demand the first right to buy the re-sale. This right is granted to franchisors as a general rule and is not negotiable.
The Franchisor’s Right of Approval
Another general rule that applies to the franchise industry is the Franchisor’s Right of Approval. The franchisor controls the brand, and the brand’s continued prosperity is largely dependent on the franchisees’ cumulative success. For this reason, franchisors do not want buyers who will likely fail. The Franchisor’s Right of Approval to reject or accept a prospective buyer of a re-sale is not negotiable.
On the other hand, there are terms and costs that sometimes can be negotiable. A few of the important ones follow:
- The Transfer fee
- Size and scope of Territorial Rights
- Terms of payment for Franchise Fee
The transfer fee
How negotiable the transfer fee is depends largely on the view or attitude of the franchisor toward the franchise seller. If the seller has performed well, the franchisor will not be desperate to facilitate the transfer because risk is always involved in a transfer that is already a prosperous operation. To the contrary, if a seller has incorporated shoddy practices, causing lower sales volume and a scar on the brand image, this hurts the franchisor. In a hostile relationship between the franchisor and seller, the buyer can almost always negotiate a reduced transfer fee.
The same is true for royalties the franchisee has to pay as a percent of sales volume or gross profit. Franchisors will sometimes consider providing Royalty Relief if the relief will expedite the transfer from a seller who has performed poorly. This relief is usually a reduced percentage or in some cases a complete cut of the fees for a set period of time, and is definitely negotiable.
The size & scope of territorial rights; the terms of payment for franchise fee
Franchisors with godfather brands that have twenty or thirty years built into their franchise operations rarely negotiate the size and scope of territorial rights nor the terms of payments for their franchise fee. Smaller franchisors with less-mature brands, however, will have plenty of territory remaining to open new operations. They’re also likely to be more flexible, to enable rapid growth of their franchise model, regarding the franchise fee. Franchisors, big or small, depend on royalties and franchise fees to continue their enterprises. Thus, the amount of the franchise fee is unlikely to change, but the up-front cost and payments on the fee thereafter are negotiable.
Another point of consideration is the situational or market circumstances of individual re-sales. Before attempting to squeeze savings from an agreement, the buyer must investigate the franchise itself. How strong is the overall brand? How good is the re-sale location regarding foot traffic and demographics? Just like haggling over a used car sale, the process of negotiating a franchise transfer is similar, in that information about the re-sale should be leveraged for the best closing deal. If a car had no air conditioning, the buyer would necessarily use such a detail to negotiate a lower price. Each situation is different, yet requires similar leveraging in franchise transfers, in response to the data obtained during research. For instance, how much will the buyer need to invest in advertisements? Did prior litigation or bad seller habits harm the location’s potentiality? Do the records in the Franchise Disclosure Document reflect low profit margin or low revenue volume? Is the lease of the location prohibitively expensive?
Answers should be found for these questions. Too many negative answers would indicate the need to find another re-sale opportunity. However, if most of the fundamentals seem solid, having knowledge about the few negative ones is imperative to negotiating the best deal. In addition, by focusing the leverage only on terms that are commonly negotiable, the buyer enhances the benefits of due diligence. This shows the franchisor how responsible and serious the buyer is in advancing the brand, and that’s usually what leads to a visit to the corporate office for Discovery Day.
Cost of using a franchise attorney for buying a franchise
Before making any commitment to buying a franchise resale, it is essential that prospective franchisees take appropriate professional advice from an experienced franchise attorney. Remember that a franchise contract is long-term; therefore the money you spend on expert advice from an attorney could be one of the best investments you make. They will guide you through the various stages of purchasing your franchise resale as well as ensuring that the Franchise Agreement fits in with all of your requirements.
The amount that a franchise attorney will charge you for this type of work will depend upon how complex the transaction is, therefore it is not really possible to give a meaningful estimate of the cost without full details of what the transaction will involve. Suffice to say that the cost will be appropriate to the value of the deal and without such advice you risk losing a substantial amount.
It is vital that you always seek legal advice for buying a franchise resale. Even if the current franchisee tells you that they used an attorney so you do not need to, you must still take legal advice from an experienced franchise attorney as the situation may have changed since the current franchisee entered into their agreement.