The purchase of a franchised business is different from acquiring a non franchised business because you are acquiring not only the business its self but also the rights to operate the business using the franchisors system. This involves you signing a franchise agreement with the franchisor as part of the sales transaction.
For this reason Franchise Resales strongly recommends you only use a solicitor who is affiliated to the British Franchise Association and who therefore fully understands the complexities of a franchise acquisition. This way you will not only receive expert specialist advice but it is most likely it will be less expensive advice because the BFA Affiliated Solicitor will have had experience of similar transactions and can swiftly act to provide the information or solution you require. The following advice is provided by John Pratt of soliciors Hamilton Pratt.
THE LEGAL ASPECT OF RESALES
When a franchise owner decides that the time is right to sell his franchise business the first step is to discuss this with the franchisor so that the franchisor is "on side". Franchise agreements will often set out the process for selling the business which usually involves obtaining the franchisor's consent to a sale and the franchisor approving the proposed purchaser. Franchise agreements also usually set out the various fees that have to be paid to the franchisor on a resale – usually a small amount - £500 – for approving a purchaser, a percentage of the initial fee – usually 50% - if the sale goes ahead to reimburse the franchisor its training and administration costs involved in the resale and lastly a "finders" fee of usually 10% of the sale price if the franchisor has introduced the purchaser.
Increasingly franchisors are becoming actively involved in the sale process by preparing a standard resale agreement which is fair to both parties and requiring their lawyers to be involved in the process so as to push the transaction through – the danger is that if franchisors are not involved lawyers for the selling and buying franchisees treat it as a confrontational transaction which increases the costs and difficulties involved!
The first decision that a selling franchise owner should make is whether to sell shares – this only applies if the franchise was operated through a limited company – or assets. These two alternatives require different agreements, so it is important to establish this at an early stage. Usually a discussion with your accountant would establish which is most attractive although bear in mind that what is attractive to a seller may be unattractive to a purchaser! The second stage is obviously to agree the price. In many business sale transactions the price is not paid immediately and there can be complex "earn out" payments based on the future profits of the business, but for the great majority of franchise resales you would expect all of the purchase price to be paid at completion of the sale.
Selling franchisors need to provide, sometimes with the help of franchisors, an information pack setting out as much information as possible about the business that is for sale. This pack should contain not only financial information so that a purchaser can see how the business has been doing but also financial performance trends. In addition information about customers, premises, employees and major contracts should be provided. The more accurate and detailed the information, the more smoothly the transaction will proceed.
Based on the information provided by the selling franchise owner the prospective purchaser will make an offer and contracts tailored to the particular transaction will have to be prepared. Business sale agreements are, by their nature, complicated because they have to set out clearly what is being sold, when and at what price as well as the obligations of the selling franchise owner to assist in a smooth transfer of the business, the obligations of the incoming franchisee to enter into the franchisor's franchise agreement and to undertake initial training as well as the apportionment of overheads of the business up to the sale date.
An area that often causes difficulty are the warranties. Warranties are statements about the business which the selling franchise owner is required to make in the sale agreement. In many business sale agreements warranties can run to 30 or 40 pages but for a relatively simple franchise business you would normally expect limited warranties to the effect that the selling franchisee owns all of the assets which are being transferred, there are no disputes, the financial information that has been provided is correct and there is nothing that the selling franchisee knows about the business and which could have a material impact on the purchaser's decision to proceed that has not been revealed to the purchaser. Selling franchisees are required to be as up front and as truthful as they possibly can be.
Notwithstanding the use of warranties to protect a purchaser, purchasers should undertake what is called "due diligence" which means a full and thorough investigation of the business. Purchasers should never assume that what they are being told is true, although hopefully it will be!
The normal process is that once the terms of the sale agreement have been agreed between the seller and the purchaser and the franchisor has approved its terms - usually franchisors are a party to the agreement to ensure that their interests are protected - the agreement is signed – this is referred to as "exchange of contracts". At that stage the purchaser will pay 10% of the purchase price and this is usually held by the franchisor's solicitor. The purchaser also enters into the franchise agreement and completes the initial training. Once these elements have been completed and any other conditions set out in the agreement have been satisfied, "completion" takes place – this is the day when the business is actually transferred to the purchaser. Exchange of contracts is the date on which there is formal agreement to sell, but the sale only takes place at completion.
John Pratt is the immediate past Legal Advisor to the British Franchise Association and a past Chair of the International Bar Association's International Franchise Committee. He is the current Director of the American Bar Association's International Franchising Division. He has written "Franchising: Law & Practice", "The Franchisor's Handbook" and contributed the franchise section of a number of franchise publications. John obtained his law degree from Oxford University and completed a doctorate course in Comparative Law at the Université d'Aix-Marseille.