Cinching the Deal: What franchisors look for in franchisee transfers
Congratulations, you’ve found your buyer, agreed on a purchase price, and have a deal in place to sell your franchised business. You are months away from realizing the value of the hard-earned equity you have built over the years through countless hours of work, investing, and reinvesting—and in many cases, risking it all to achieve your dreams. There is just one catch: Since you are selling a franchised business, the franchisor also has a role in the process. While the exact terms, conditions, and protocols vary from brand to brand, the level of franchisor involvement in transfers today has evolved beyond a simple “No” on their right of first refusal or rubber stamp approval.
Brand approval process
A negotiated deal between a buyer and seller only starts the final approval process. It is important to first understand brand franchise documents to determine how and when best to alert your franchisor of the contemplated transaction. In almost all cases, the buyer and seller are required to send their purchase agreement or other written sales document to the brand for review. The franchisor then has final approval, and the seller and buyer must anticipate and do their best to manage the approval process. Follow the rules and established protocols. Seek counsel from attorneys, deal advisors, and fellow franchisees, especially those with insight or experience working with a particular brand on previous transactions.
When evaluating franchisee transfers, franchisors look at various factors, including the following:
Operational experience. Expect the franchisor to ask pointed questions around background, experience, plans to support and operate the units, spans of control, audits of existing facilities, even if these are in another brand. Are the acquired locations contiguous to existing markets?
Financial capabilities. How is the buyer paying for the transaction? Expect the franchisor to thoroughly analyze the buyer’s credit history, liquidity, and debt structure for acceptable leverage ratios. In addition, the buyer may have remodel or reimage obligations and/or new unit development requirements whose costs extend well beyond the initial purchase price. All partners in the process will be vetted. In most cases, owners with 20% or more will be required to guarantee franchise obligations.
Legal requirements. Ensure that all documents and franchise documents are reviewed by experienced counsel to ensure brand compliance. In addition to the operational and financial requirements of a buyer, it is important to also make sure a buyer is brand compliant. This most frequently becomes an issue regarding competitive concepts and the expanding noncompete requirements brands are placing on their franchise systems. This can be an immediate reason a transaction is not approved.
Conditional brand approval
Increasingly, brands are conditionally approving transactions based on buyers agreeing to certain terms, often in the form of future development obligations. It is important to understand any development requirements and penalties associated with noncompliance, as these can vary widely depending on the brand and geography. Another common condition for approval is an accelerated remodel or reimage timeline.
The additional requirements can affect value and the interested buyer pool. Will a buyer ask the seller to split some of the cost? Does a transaction still make sense? Both development and reimage requirements must be managed to ensure brand approval.
Right of first refusal (ROFR)
Most brands have a definitive ROFR in their franchise agreements. It is another tool brands use to influence franchisee transfers. ROFR can impair marketability if there is substantial risk of a franchisor invoking its rights. But more often than not, brands use their ROFR in combination with the approval process to steer transactions to preferred candidates—which may not always align with maximizing your value in a sale. Brands may favor different franchise groups based on:
- Capitalization, equity contributions, financial capability, and commitment to new unit development
- Franchisee geography within DMAs, trade areas, etc. Many brands are resistant to seeing franchisees expand beyond their core footprint or in nonadjacent states and markets.
- Size of franchise groups. Many brands don’t want groups becoming too large too fast. Some want larger franchisees to take over turnaround situations that require patience and capital. Every situation is different.
If a buyer feels there is substantial risk of nonapproval, they may be reluctant to incur expenses to move the transaction forward related to legal and diligence. In such instances it may be in everyone’s best interests to structure a split or partial seller reimbursement of expenses.
If the brand does exercise its ROFR, it is the fastest and most certain way to recognize value. To protect value however, it is important to have a fully executed purchase and sale agreement in place, or as close thereto as possible. The timing of when to approach the brand about a transfer and the execution of a purchase agreement doesn’t always align, and is always a critical juncture in every transaction.
Have a strategy before bringing the franchisor into the process. Every brand and every transaction is different. In some cases, the seller might want to bring them into discussions early; for others, it is when the contract is complete. Deciding who to speak to at a brand can be equally important. Sometimes speaking to two different people at the same brand can result in two different answers. Be aware of previous transactions. Speak to other sellers. Then you can develop a plan for how, when, and at what level to communicate with the franchisor.
Carty Davis is a partner with C Squared Advisors, a boutique investment bank that has completed hundreds of transactions in the multi-unit franchise and restaurant space. Since 2004 he’s been an area developer for Sport Clips in North Carolina with more than 70 units. Contact him at 910-528-1931 or email@example.com.
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