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The purchase or sale of a company or business is a complex process that requires dedication and specific knowledge. However, if it involves buying or selling a business that operates under a franchise system, an additional layer of complexity is added, as this will involve a three-party transaction: seller, buyer, and franchisor.

Whether when acting as a seller or a buyer, it is essential to involve the franchisor from the outset and consider the following aspects.

Franchisor’s Authorization

Franchise agreements are “intuitu personae” contracts, meaning that they are granted based on the characteristics or qualities of a particular person (the franchisee) and, therefore, this person cannot be replaced by another without the prior authorization of the franchisor. The authorization clause is usually included in all franchise agreements.

When franchisors grant a franchise agreement to a franchisee for the first time, they analyze the suitability of that person to be a franchisee of their brand; the previous experience, financial capacity, availability for training, possible incompatibilities, etc. Once all these elements have been analyzed, franchisors will decide whether to admit that person into their franchise network. The same will happen if someone wants to buy an already operating franchised business. The franchisor will analyze the suitability of the buyer to be part of the franchise network, and based on the result of the analysis, will decide whether to authorize the transaction.

For instance, if the potential buyer is already operating another business that competes with the franchise, or if it does not have the required financial solvency to continue the business, it is most likely that the franchisor will not authorize the transaction. If the sale is carried out in contravention of the authorization clause of the franchise agreement, the franchisor would be entitled to terminate the contract, meaning the buyer would have acquired a business that cannot continue its activity.

Right of First Refusal

Most franchise agreements include a right of first refusal for the franchisor in the event that the franchisee wants to sell the business. This means that if the franchisor is interested, it can acquire the franchisee’s business with preference over a third party and under the same conditions offered by this third party. Therefore, when a franchisee wants to sell its business, it must not only obtain the franchisor’s authorization but also offer the franchisor the opportunity to acquire it preferentially.

For the buyer, it will be essential to have written confirmation, before starting the purchase process and incurring all the expenses associated with such a transaction, that the franchisor does not wish to exercise their right of first refusal. It is advisable to include this condition in the Letter of Intent signed by the buyer and seller, so that the franchisee can present it to the franchisor and obtain the waiver of its right of first refusal. Once the buyer has written confirmation of the waiver, can proceed with the due diligence process.

Transfer Fee

Another element to consider when negotiating the purchase of a franchised business is the common practice in many franchise agreements of including a fee in favor of the franchisor in the event that the franchised business is transferred to a third party. The existence of this fee is usually justified by the fact that if the selling franchisee obtains a significant profit from the sale of the franchised business, the franchisor also wants to receive a percentage of it, and that the transaction will require some dedication from the franchisor to evaluate the suitability of the buyer as a new franchisee and the need to train the buyer on the franchised business model.

The amount of the transfer fee can be a fixed amount specified in the franchise agreement, a variable amount usually linked to the sale price, or a percentage of the  business’ turnover during the twelve months prior to the transaction.

If the fee is to be paid by the seller, it will reduce the net amount ultimately received from the sale of the business, while if it is to be paid by the buyer, it will be an additional cost to the agreed purchase price. For this reason, it is important to verify, before making the final economic offer, whether such a fee exists and its amount. Depending on the circumstances of the transaction, it is always possible to negotiate with the franchisor to reduce the amount or even eliminate it if, for example, the sale of the business is due to economic crisis circumstances and the franchisor is interested in facilitating the entry of a buyer with more financial capacity.

New Franchise Agreement

There is the possibility that the franchisor may require the buyer to sign a new franchise agreement, the terms of which may differ from the existing franchise agreement. Remember that franchise agreements are multi-year contracts and franchisors periodically update their terms.

In this case, it will be crucial for the buyer to analyze the terms of the new franchise agreement in advance, as these could affect the future profitability of the business and, therefore, influence the purchase price offered to the seller.

Closing the transaction

The closing of a purchase and sale transaction is usually a complex moment that requires foresight and coordination, with the signing of the purchase and sale agreement, its notarization, payment of the purchase price, delivery of guarantees, approval of corporate changes, ultimate ownership disclosure, declaring the foreign investment, etc. When it comes to the sale of a franchised business, an additional element is added, such as the franchisor’s final approval of the sale and the possible signing of a new franchise agreement.

It is not necessary for the franchisor to be present at the time of signing the sale, but it is important to anticipate the documents that must be obtained from the franchisor for the closing of the transaction, so that the buyer is certain that it is purchasing the franchised business with the franchisor’s authorization and under the agreed franchise terms.

Having proper support and legal advise is essential to ensure a successful transaction.

For more information or advice, you can contact us at info@gimenezsalinas.es.

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