Post-Pandemic Requirements for Buying or Selling Franchised Businesses
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Post-Pandemic Requirements for Buying or Selling Franchised Businesses

Post-Pandemic Requirements for Buying or Selling Franchised Businesses

Editor’s note: This article was first published in the June/July issue of Independent Joe, the magazine for Dunkin' Donuts Independent Franchise Owners (DDIFO) and is reprinted with the permission of both the author and the magazine. While this was written for Dunkin’ franchisees, the lessons and advice apply to anyone looking to buy or sell a franchised business during Covid.

The coronavirus pandemic has had a profound impact on the restaurant industry. By the beginning of Q4 2020, more than 1.4 million jobs in franchised businesses were lost and more than 32,000 franchised businesses had closed. Now, with states opening up and a gradual return to business as usual, we are cautiously approaching the light at the end of the tunnel. But the return to “normal” is still prompting many operators to contemplate their future as Dunkin’ franchisees.

Those considering exiting the system cite difficulties in the labor market, a lack of any formal succession plan, the daunting capital expenditures that will be required to complete impending remodels, or simply fatigue from the stress fostered by the pandemic as reasons to sell. At the same time, less risk-averse franchisees eager to expand their existing networks through acquisition see an abundance of opportunity. But caveat emptor: the pandemic has created a number of new pitfalls and obstacles potential buyers must navigate when contracting to purchase additional restaurants. Let’s look at four of them here. 

1) Valuations

Franchisees are finding it difficult to determine the actual value of the restaurants they want to sell because the pandemic so severely altered their 2020 financials. Some sellers will seek to treat 2020 as an anomaly and implement a blended average methodology, whereby 2019’s pre-Covid financials are taken into consideration when valuing their networks. But that strategy comes with a risk. There is no guaranty their store’s performance will return to 2019 levels; thus, the ensuing valuation may be artificially inflated, resulting in the buyer overpaying for the restaurants.

Within Dunkin’, where 2021 system-wide performance is comping over that of 2020, many sellers are finding it more beneficial to use the more customary trailing 12 months’ sales as a benchmark for valuation. Under such circumstances, buyers must be cautious to recognize that 2021’s sales figures are likely enhanced by: 1) an increase in average product pricing, and 2) the stimulus checks, which were rolled out as part of the CARES Act.

2) Drive-thrus

The contact-light drive-thru model became the savior of quick service restaurants during the pandemic. Within Dunkin’, restaurants without drive-thrus were hit the hardest and comprise the vast majority of stores closed throughout the system. To the contrary, most Dunkin’ shops with drive-thrus showed remarkable resiliency throughout the pandemic and continue to outperform in 2021. The net effect of this reality is that non-drive-thru Dunkin’s are much more difficult to market and sell. In fact, the inclusion of non-drive-thru restaurants in a Dunkin’ network may adversely affect valuation where a buyer is forced to consider the costs of eventually closing and relocating such sites.

3) Covid-deferred rents

At the onset of the pandemic, many Dunkin’ franchisees were able to negotiate with their landlords for rent deferments. In certain instances, the deferred rent was to be repaid as “additional rent” throughout the remaining life of the lease. For a buyer, it is critical to require that the seller repay all such deferred rents on or before the closing date. Failure to do so could result in the buyer being saddled with the additional rent payments post-closing, despite having not received any of the benefits conferred by the deferment.

4) CARES Act funding

The two most prevalent forms of CARES Act funding Dunkin’ owners took advantage of during the pandemic were the Paycheck Protection Program (PPP) and the Economic Injury Disaster Loan (EIDL).

The PPP funds took the form of an unsecured loan, which, if used for its intended purposes, can ultimately be forgiven by the SBA. On Oct. 2, 2020, the SBA issued a notice, setting forth the required procedures for changes of ownership of an entity that had received PPP funds. Among the mandates is the requirement that the seller of any business with yet-to-be-forgiven PPP loans obtain consent for the transaction from their PPP lender. Consent entails a two-step process: 1) the borrower must apply for the forgiveness of all outstanding PPP loans; and 2) the borrower must enter into an agreement with their PPP lender to escrow the full amount of all outstanding PPP loans until forgiveness is granted. As a result, any prospective buyer of a Dunkin’ network should condition the closing of the transaction on the seller obtaining all necessary third-party consent, including that of the PPP lender.

EIDL loans were made directly by the SBA to many Dunkin’ owners. Unlike the PPP funds, EIDL loans in excess of $25,000 were secured with blanket liens on all of the borrower’s business assets. Thus, in advance of any closing on a Dunkin’ acquisition, the seller should be required to obtain a payoff letter from the SBA, including the full amount of the payment necessary to satisfy the loan, and a covenant to terminate the lien upon receipt of such payment.

Forbes magazine recently quoted IFA data predicting 2021 will bring the largest yearly growth in franchise establishments ever. We will have to see if that comes to fruition, but many units are already changing ownership. As such, it is more important than ever that franchisees adhere to their attorneys’ advice.

David S. Paris is a founding partner of Paris Ackerman LLP, a transactional law firm specializing in franchising, licensing and distribution, and commercial real estate. You can reach him at dparis@parisackerman.com.

Published: August 6th, 2021

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