Negotiating Franchise Agreements and Letters of Intent

The franchise industry is seeing one of the strongest growth spurts in history. Combine this with a strong economy and it is no wonder that current franchise owners are looking to expand, and those looking to invest in growth areas are eying the franchise world. With any investment, whether you are familiar with the industry or not, there are key considerations to keep top-of-mind as you seek to grow.

Look at some of the most recent articles published here and you will easily find a trending theme related to growth in the franchise world. Examples include a private equity firm investing in one of the largest Planet Fitness franchise groups and a former NFL linebacker looking to build out 100 Jersey Mike’s. In our last two articles, we also tackled growth from a variety of perspectives. We touched on how to be equipped for funding your growth, and growing without cannibalizing your sales.

One critical way to engage in smart growth, for both new comers to the industry and for more experienced players looking to build out their portfolios, is to pay close attention to the terms of your typically long-term franchise agreements. Lisa Payrow, partner with the law firm Arnall Golden Gregory LLP, shares that franchise owners can negotiate their franchise agreements, especially if you, as the potential franchise owner, have leverage in that the franchisor is a start-up and/or you are agreeing to open several franchise locations.  A few key provisions of the franchise agreement that can and should be negotiated include:

• Territory size and exclusivity; and a right of first refusal for additional development
• Decreased royalty fees or a “ramp up” of royalty fees over the first several years
• Capped or decreased other fees, such as with respect to transfer and renewal
• Strengthening your right to cure defaults prior to the franchisor’s right to terminate
• Removing “cross-default” and liquidated damages provisions
• Eliminating the requirement of a personal guarantee; or limiting the types of fees to which it applies and/or capping the potential liability

Perhaps you are looking to grow by buying a franchise location from another franchise owner. Here, Payrow suggests that you should use your letter of intent wisely as a negotiating tool. Of course, it is recommended that you always have your strategic advisors involved at this stage of the process, but consider your letter of intent as an entrée into negotiations for what you want in the deal. Payrow shares that the seller may also have some big-ticket items that they would like to negotiate, and knowing them up front will ensure that you have a mutual understanding of what is and is not negotiable. Key terms to address in your letter of intent include:

• Purchase price and payment terms. As a buyer, consider whether to include a financing contingency or request seller financing.
• Transaction structure, such as an asset or equity acquisition. Include a list of key assets to be acquired.
• Earnout terms. Be very clear about when and how the earnout will be measured and earned. The seller should ultimately consider the earnout as a bonus rather than guaranteed purchase price.
• Working capital targets and adjustments. Again, the parties need to be absolutely clear about what the targets are and how working capital is calculated.  We recommend using actual examples to illustrate any formulas.
• Holdbacks and escrows, such as for indemnification, including amounts and terms.
• Limitations on liability, including any baskets or caps, and the survival period for representations and warranties.
• Terms of restrictive covenants, including non-compete and non-solicit restrictions. Also, the key terms of any post-closing employment agreements, if you will retain the seller’s principals or key employees.
• Any specific indemnification that you will require, such as “our watch/your watch”, but reserving the right to ask for more based on due diligence.
• Exclusivity or “no shop” period for negotiations and any “break up” fees.

Regardless of your method of growth, there are critical areas to consider, no matter the franchise entry level or type. Growth is not only through acquisition. In our next article, we will tackle what franchise owners need to be paying attention to if looking to exit a franchise brand or location by selling their franchise.

 Kendall Rawls knows and understands the challenges that impact the success of an entrepreneurial owned business. Her unique perspective comes not only from her educational background; but, more importantly, from her experience as a second-generation family member employee of The Rawls Group - Business Succession Planners. For more information, visit www.rawlsgroup.com or email info@rawlsgroup.com.