Can I Sell My Franchise?
If you are considering buying a franchise, it is vital to know what the terms of the contract are concerning selling the franchise at a later date. This may be the furthest thing from the minds of potential franchisee owners, but must be taken into consideration at the time of purchase.
A franchise is a licensed contractual right which is not necessarily transferable – unless there is a provision in the agreement to transfer and/or novate those rights. Novation is the substitution of a new contract for an old one whereby the new agreement extinguishes the rights and obligations that were in effect under the old agreement.
The Franchising Code of Conduct requires that franchisors disclose whether a right to transfer a franchise exists and, if so, the conditions of transfer. Even if there is no express provision for transfer in the agreement, a franchisee may still request the franchisor to consent to a transfer. However, there is no contractual obligation on the franchisor to consent.
Don’t assume you can sell
The code provides that a request for franchisors consent to transfer or novation of a franchise must be made in writing. The code does not expressly require that there be a right to transfer or novation in a franchise agreement. It is often just assumed by franchisees that such a right exists.
The Code of Conduct is a mandatory industry code. Franchisors cannot contract out of their legal obligations. Careful attention should be paid to the grounds for refusal. Make sure the grounds are reasonable and that they comply with the code and that any ﬁrst right of refusal to the franchisor is on no less favourable terms than a third party is prepared to offer.
Generally most franchise agreements provide a procedure allowing for the franchisee to sell the franchise, subject to the franchisors approval and a ﬁrst right of refusal.
What are reasonable grounds for a franchisor to refuse a prospective franchisee?
The code sets out grounds upon which it is reasonable for a franchisor to withhold consent. Those grounds include the following:
(a) The transferee is unlikely to meet the ﬁnancial obligations under the franchise agreement. The franchisee effectively does not have sufﬁcient working capital, assets and reserves.
(b) The transferee does not meet a reasonable requirement of the franchise agreement for transfer. This is open to broad interpretation.
(c) The transferee has not met the selection criteria. This usually relates to the franchisee being, for example, unable to speak the language or failing training requirements.
(d) The transfer would have a signiﬁcant ‘adverse effect’ on the franchise system.
This is open to broad and subjective assessment by the franchisor.
(e) The transferee does not agree in writing to comply with the obligations as a franchisee. This is a most curious provision!
(f) The existing franchisee is in default of his or her obligations and has not made reasonable provision, or cannot pay amounts owing to the franchisor, even should he transfer the business.
(g) The franchisee has breached the agreement at the time of transfer and not remedied that breach.
The code provides that a franchisor must, within 42 days after a written request for transfer, give the franchisee written notice that consent is withheld and reasons why consent is withheld. If the franchisor does not provide that consent in writing within 42 days of the franchisees request, the franchisor is taken to have given its consent.
The process of transfer and assignment involves a balancing of the rights of the franchisor to protect their interests, brand and reputation. As well as the right, if expressed in the franchise agreement, of the franchisee to sell his or her business and licensed rights.
On a transfer or sale of the franchise business, the code requires the franchisor to give a current disclosure document to the incoming franchisee.
Is there a good time to sell your franchise?
Franchise agreements are for all sorts of terms. The code does not require the franchisor to grant any minimum term. Therefore a franchise right can be granted for 12 months, three years or 20 years.
There is no obligation in the code for a franchisor to grant a further term or option to the franchisee.
Selling a franchise within the ﬁrst two or three years is not an opportune time and is likely to crystallise a loss to a franchisee.
Most business plans provide for a return on investment (ROI) to a franchisee after three or four years. The up-front capital costs of entering into the franchise are generally amortised over the first two to three years.
Therefore, it is unlikely that a franchisee will be able to ask for any good will or obtain a return on their capital costs if they sell in the ﬁrst two to three years, although that will depend on the nature of the franchise. Having a trading history and showing ﬁnancial statements that are up-to-date, as well as providing for a reasonable wage and proﬁt to the operator, will place a franchisee in the position to have something to offer a prospective purchaser.
What is my business worth?
Franchisees should understand the basic principle of franchising, which is that the goodwill built over time by the franchisee is really that of the franchisor, as the franchisee is trading on the franchisors brand and system. The franchisee is granted a licence (a contractual right) to operate the business under that brand and system. The good will at the end of the franchise term remains that of the franchisor. Any good will that a franchisee can recover on sale will depend on:
(a) whether the value of the franchise system as a whole has increased over time
(b) whether the individual business itself is proﬁtable
The vendor may ask for a multiple of its proﬁt. This could vary from the previous years’ net proﬁt, the average of the last two or three years net proﬁt or a multiple of three to ﬁve years proﬁt. There are other valuation models that can also be used.
At the end of the franchise term, if there is no further option, the licence ends. The franchisee is required to de-brand. In that event, the only obligation on the franchisor is to pay the franchisee the depreciated or written down value of the franchisees plant and equipment and stock.
There is no obligation on the franchisor to buy back the business from the franchisee or recognise any good will that may have been built by the franchisee over time. Why? Because it is the franchisors goodwill.
Is a franchisee entitled to renew for a further term?
Franchisees should not assume the franchisor will grant the franchisee a new franchise agreement for a new term at the end of their contract or grant the new incoming franchisee a new franchise agreement if they sell the business. There is no such obligation under the code or in franchise agreements that give franchisees that right.
It is therefore best to communicate with the franchisor before placing your franchised business on the market for sale. Clarify the franchisors policy and position concerning the sale of the franchise. Will they agree to grant a new franchise to the purchaser or will they only agree to transfer the unexpired term of your franchise? This can be a critical question that will impact on the value of your business. Often the franchisor will agree to enter into a new franchise agreement with the purchaser as the franchisor can then ensure their latest form of franchise agreement is in place.
So when should I sell my franchise business?
The code was amended on 1 July 2010 to require franchisors to disclose what is to occur at the end of a franchise term.
The code provides that if a franchise agreement is for a term of six months or longer, the franchisor must notify the franchisee at least six months before the end of the term of the franchisor’s decisions to renew or not to renew the franchise agreement or to enter into a new franchise agreement.
Many updated disclosure documents now meet that requirement by simply indicating that there is ‘no right to renew’ the franchise agreement at the end of the term – without any further notice being provided by the franchisor.
The best time to sell your franchise business is shortly after renewing the franchise agreement, whilst you still have a reasonable term left. However, if you only have two years left of your franchise term without knowing the franchisors position, then you have little to offer a buyer.
Don’t expect the franchisor to be cooperative if you are in default of your obligations at the time of your sale. Also don’t overlook your lease term. If the franchisee holds the lease, how much is left on the lease term as opposed to the term on your franchise? They often are not the same.
As with any business you need to plan for a sale. This requires work in the early stages, even before you place the business on the market check that your ﬁnancials are up to date. You should work closely with your accountant and lawyer to prepare for sale.
The costs of selling your franchise business
Before commencing the process of selling, ensure you understand the cost and exit fees. You should take these into account in your negotiations with a prospective buyer.
The costs of selling can be considerable, including:
(a) business agents fees and advertising
(b) landlords costs to approve the incoming franchisee
(c) the franchisors costs, which can be a ﬁxed fee or a percentage of the sale price
(d) capital gains tax on eventual sale
Plan how to sell your business BEFORE you buy it
Before you buy your franchise business, plan how to sell it. Do your homework. Get expert advice from a franchise lawyer and your accountant and identify the issues, costs and process. Understand the legal constraints of your contract with the franchisor.
In the event you do want to sell your business, don’t accept the ﬁrst purchaser that comes along. Do your due diligence on the buyer just as they will undertake their due diligence on you.
Will the franchisor approve the prospective franchisee? Do you think the purchaser will be able to successfully complete training? Does the purchaser have the capital to acquire the business? Do they need to obtain ﬁnance? If so, how much?
By asking these questions at the earliest opportunity, you may save yourself time, costs and considerable disappointment.
Robert Toth is a Partner with Wisewould Mahony Lawyers and has authored many articles on franchising and dispute resolution in franchising. He acts for a number of international franchisors and companies and has assisted them to establish business operations in Australia.
Wisewould Mahony is an Australian law ﬁrm that is recognised in the area of franchise law providing clients with corporate and commercial advice.
Contact Robert at:
Phone: 03 9612 7297