Selling a Business: Franchises and 3rd Party Consent
18 October 2021: Selling a Business/Franchises
Last week’s post – on the need for third-party consent to sell a business – was relatively general in topic but raised more questions and comments than I anticipated. That reaction illustrated a need to be a bit more specific, so let’s dive into this topic a little further.
The idea that a business owner would be required to get the consent of someone or some entity that has no ownership in the business before the owner can sell their business seems to have surprised many readers. But more often than not, that’s the case.
And though last week’s post focused on one of the most likely consents required – the landlord’s – there are certainly others that might be needed.
For example, a lender’s consent might be required if the sale will include any asset that the lender has a lien against.
It’s also possible that a customer or client would have to consent to a sale if the business’s contract with the customer includes a “change of control” clause.
But, other than the landlord example, one of the most widely occurring instances in which a third party’s consent to the sale of a business would be required is when the business being sold is a franchise.
The Franchise Market
There are more than 3,000 established franchise systems in North America, 935 in the U.K. and hundreds more in Europe and Australasia.
According to Statista.com, there are roughly 775,000 individual franchised businesses in the United States alone employing more than eight million people. In the U.K., those numbers are 48,600 and 710,000 respectively.
Existing franchise units get sold every day. If you’re helping broker the sale of businesses, you’re very likely to come across more than one in your practice.
Why would an owner of a franchised business sell? Well, for the same reasons the owners of any business will sell.
But one of the main issues that owners of franchised businesses must contend with when selling is that they are contractually obligated to the franchisor to operate their business for a certain period of time.
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Most franchisors require their franchisees to sign multi-year contracts – often five- and 10-year terms – so, unlike the owners of independent businesses, the owners of franchised businesses – referred to as “franchisees” – are locked in to a franchise operating agreement that requires them to operate their business for X period of time.
But like the owner of any business, it’s not unusual for franchisees to experience some life-altering event at any time during the term of their franchise agreements. When these events happen, they often want to sell.
The Franchisor’s Consent
But franchisors are always involved in every big – and many not-so-big – decision that a franchisee makes about the franchised business, including the sale of that business; especially the sale of the business.
Since franchisors own the exclusive right to the intellectual property – trademarks, trade names, business systems, etc. – of the business, they restrict the right to open one of their franchised businesses to individuals that go through a lengthy and arduous approval process.
Any potential buyer of an existing franchised unit must also go through the same approval process. As with the seller, the original owner of the franchise, the franchisor wants to make sure the buyer is capable of running the franchised business using the same business-method systems and presenting the business to the ultimate customers the same way the seller did – as required by the franchise agreement.
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All franchisors have their own unique set of qualifications which must be met by any new franchisee.
Before the sale of a franchised business, the buyer, once approved by the franchisor, will be required to sign a franchise agreement as did the seller – and as does anyone that wishes to open one of the franchisor’s units.
As for the financial terms of the sale, even if the buyer is vetted and approved by the franchisor, the franchisor gets final approval over them.
This includes the purchase price of the franchised business and in many cases, the financing terms of any loan to acquire the business.
My experience in the development of three franchise systems in the 1990s includes the drafting, with counsel, of the myriad and lengthy documents required to establish a franchise system.
Aside from the seemingly interminable language in the documents that focus with a laser-like intensity on how a franchisee is to operate its business, one of the most arduous sections deals with the franchisee’s ability to transfer – that is, “sell” – the business. The language in the transfer section is onerous and restrictions abound.
Most franchise agreements give the franchisor the first right of refusal to buy the unit and a way of determining what a “fair price” might be is outlined in this section. Most such agreements also contain the requirement that a “transfer fee” be paid to the franchisor.
The Bottom Line
Selling a franchised business is a perfect example of when third-party consents are needed.
And, as I mentioned in last week’s post, most businesses operate in leased space. (McDonalds Corporation owns more real estate than any entity in the world.) Aside from franchises that can be operated out of the franchisee’s home, most operate in leased premises. This means that at least two third-party consents – the landlord and the franchisor – will need to be obtained for the sale of many franchised businesses.
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
This week’s “Searching” item comes from a small private equity group looking for a U.S.-based Industrial Services (i.e. repair and replace, calibration, maintenance, equipment monitoring) with discretionary earnings of between $1 million and $5 million.
If any of you know of something that might fit, please let me know.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.