Speaking terms - buying and selling a franchise

When you buy an existing franchise from an outgoing franchisee, do you get a brand new franchise term for, say, five years, or are you just assigned the unexpired portion of the existing term? As you might imagine, it can make a big difference.

It is fairly common to receive a whole new franchise term. This has benefits for both incoming and outgoing franchisees. But if a premises lease is involved, then you will usually get the unexpired portion of the term – to match the lease term.  Even then, some franchisors are willing to grant a whole new franchise term, but you should be cautious about getting the franchise and lease ‘out of sync’.

When it comes to documentation, the usual practice is to create a new franchise agreement for the new buyer. This enables the franchisor to ensure that the purchaser is on the latest form of the franchise agreement, ensuring that any regulatory and other business-driven changes are incorporated.  

 Some franchisees seem to think that assigning the existing agreement will be cheaper – but this is not necessarily the case. Also, an assignment usually leaves the original franchisee and guarantors with ongoing liability risk until the current franchise term expires. Sellers should get indemnities from the incoming franchisee and their guarantors, so they can hopefully pass on any liability, but this is only effective if the amount of the liability justifies the cost of enforcing the indemnity, and if the new franchisee or guarantors have sufficient assets to pay out on the indemnity.

Some purchasers may also want an assignment, particularly if the exiting franchisee had terms that were better than the franchisor’s current standard terms at the time of the sale. However, usually a franchisor will be able to require that the purchaser accept the franchisor’s current standard terms. In that event, whether or not a purchaser can take over the previous arrangement is basically up to the goodwill of the franchisor. If the general terms of the current agreement are the same as the exiting franchisee’s agreement, the franchisor may be relaxed about assigning the ‘old’ agreement. 

What’s it worth?

If a franchise is assigned, the purchaser will only receive the balance remaining on the vendor’s current franchise term (plus any renewal rights). A new agreement may (or may not) include a whole new franchise term. If it does include a new term, that gives the purchaser more time to recover their investment and build wealth. It’s also best from the selling franchisee’s perspective, as they effectively have more to sell and may therefore get a higher price for the business. 

Whether selling or buying, franchisees should check the length of term that a purchaser would receive, whatever the contractual structure may be. It’s highly relevant to price, from both parties’ perspective.

Taxation consequences may also arise from how the transaction is structured. Both franchisees should discuss the possible sale with their accountant as soon as possible – sometimes accountants can fine-tune the transaction for maximum benefit.

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