How a Franchisor and Franchise System Can Prepare to be Bought and Sold
In addition to the business of building the brand and system for the purpose of business success in general, some franchisors and franchise systems may have other goals in mind, including for the purpose of being sold. In order to do so, there are certain steps the franchise system will have to take in order to be appealing to buyers in the marketplace. Below are some key issues, although not all, to consider when thinking of selling your franchise system.
First, think about potential buyers. Will they be your competitors? Likely not. Competitors in your same industry would likely want to avoid purchasing a competing system and opening themselves up to claims by franchisees regarding their territories. For example, if you run a mobile cleaning service franchise system and you are bought by another mobile cleaning service franchise system, then it is possible that the territories of your existing franchisees may overlap with the buyer’s franchisees. Depending on the franchise agreements involved and the exclusivity rights the franchisees have, this overlap may cause serious friction with both sides’ franchisees. Since your competitors are unlikely candidates, potential buyers instead may include private equity companies and existing franchise systems looking to add on to their roster. Perhaps a franchise system in the home repair business is looking to expand its home services offerings by adding your home cleaning business system. In this scenario, the territorial overlap of existing franchisees is less likely an issue since the franchises offer different services and would not be competing for the same customers.
Next, prepare the franchise system’s records for the potential buyers to review. This step includes making sure the franchisee system has accurate and available financials, as well as all signed franchise agreements in the past three to five years. Also, if there are other types of agreements involved, such as addenda to franchise agreements, software license agreements, trademark license agreements, vendor agreements, etc., then these should also be organized in order for a buyer to review.
Now that you have identified all of the relevant agreements, take a closer look for “transfer-friendly” language in the franchise agreements and how these agreements have changed over time. For example, do your franchise agreements have a provision that expressly gives the franchisor the right to transfer the franchise agreement without the consent of the franchisee? And, does the franchise agreement have a provision that allows the franchisor to change the trademarks used in the system or the approved suppliers for certain items? If your agreements do not have these provisions, then consider amending the agreements accordingly, if possible.Also, it is important to understand how your agreements have changed over time. Do the first few franchisees have a much more franchisee-friendly document? Was there a big shift at some point during the history of the system when major changes such as an increased royalty, trademark changes, and/or modification to the territorial exclusivity occurred? Understanding how your agreements changed over the years is helpful in assessing how easily the buyer will be able to handle franchisee issues in the future. The more versions of your agreement of which they have to keep track, the more difficult it may be.
Another consideration is to assess any pending or upcoming litigation between the franchisor and franchisees. If the franchisor is currently involved in litigation with one or more franchisees, consider how long it will take for those cases to conclude and what the consequences may be. Also, consider whether any litigation may be upcoming by examining the relationship with existing franchisees. The more amicable the system relationship are, the better for the buyer.
On the same note, take the time to evaluate how the system has gained and lost franchisees over the years, which can be telling of the value of the system as a whole (although that’s a whole other topic). Consider the following: (i) how many prospects were disclosed vs. how many franchisees actually signed?; (ii) what percentage of franchisees renew their franchise agreement?; (iii) what percentage of franchisees were terminated?; (iv) how do franchisees that signed in the same year perform as compared to each other? Essentially, anything you can prepare to provide information on the strength and value of the system will be to your benefit. Once you have considered all of the above and any other specific issues that your system may have, you will then have to prepare a valuation formula for the system, which will hopefully be made easier based on your due diligence of the above issues.
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