A Clean Transfer: Key Considerations for Succession Planning

A franchise is not an ordinary business asset. You don't really "own" a franchise outright as you do a traditional business. What you own is a right or license from the franchisor to operate the business under the franchisor's name for a period of time (the franchise term). More important, when retirement, disability, or death requires a sale of the franchise, you cannot change ownership unless you meet the franchisor's requirements.

This difference becomes even more complicated when it involves franchisees, who may be area developers or subfranchisors and who may have more than one unit in two or more unaffiliated brands or sectors (think or burger franchisees who are also and franchisees). Not only are there different franchise terms for each of the franchises, there may be different franchisor requirements in the franchise and area development agreements controlling transfer upon retirement, disability, or death of the managing member or members of the multi-unit franchisee.

And then there are the usual concerns of suddenly being in a business with someone else's spouse or partner who does not know much about franchise duties and operations but acquires a sudden ownership interest upon death and expects to receive the income share of the departed member.

So how do you start to reconcile all these divergent factors? By recognizing that ownership is a special asset that must be protected by proper succession planning that appreciates the unique aspects of franchise and multi-unit ownership.

Consultation with a professional who is knowledgeable as to franchising, business succession, and is therefore crucial because asset protection and succession techniques can be implemented only after consent is obtained from the franchisor for the type of succession strategy being proposed. This makes the planning process far more complex than for sole proprietorships or single franchises.

The major issues to be considered in succession planning for multi-unit franchisees are:

  1. what restrictions on transfer (either internally or externally) are imposed by the franchise and/or area development agreement;
  2. the need for a comprehensive buy-sell agreement funded with sufficient to buy out the interest of a disabled or deceased partner; and
  3. an "in place" management strategy to determine who will immediately carry on management functions when unexpected change occurs.

As all franchise agreements have provisions that place restrictions on the franchisee's right to transfer the franchise (before or after disability or death), in order to enforce system-wide uniformity and quality standards, any estate plan that fails to comply with franchisor transfer restrictions will be both ineffective and may even be cause termination of the franchise.

Accordingly, both the franchisee and their attorney must contact the franchisor's legal department before going forward and adopting any estate plan. Only after consulting with the franchisor will the franchisee and their family know what can and cannot be done.

Once the specifics of the permissible transfer have been determined, the remaining specialized franchise valuation tax problems can be addressed with certainty. The valuation of a franchise or an interest in several is different from that of an ordinary business. Franchises are essentially contract rights for tax purposes--and may have far less worth than that of a traditional business. Therefore it is imperative to seek out the services of a qualified business appraiser who is experienced in valuing franchise interests. For example, if death occurs late in the term of the franchise and upon renewal the franchisee had to perform an extensive remodel and pay a higher royalty, the amount of estate tax that would have to be paid would be significantly reduced.

Remember, all good asset protection concentrates not on what a multi-unit franchise is worth, but how much the multi-unit members keep after they have successfully navigated retirement, disability, or death.

For more detailed information on business succession and visit www.marksklein.com.

Gerald "Jerry" Marks is an attorney with Marks & Klein LLP in Red Bank, N.J., specializing in representing franchisees and in asset protection and He also is author, lecturer and adjunct professor of franchise law at Monmouth University.

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