Franchising enables business owners to accelerate their expansion plans by benefiting from the knowledge and expertise of a tried and tested business system and support from the franchisor.
Franchising remains a popular business model and in Scotland, food and drink and home care and personal services franchises are particularly popular.
Whereas a franchisee might in the past have purchased a single franchise, it is not uncommon to have a plan at the outset to develop multiple sites, potentially with multiple brands. Multi-unit franchises benefit from economies of scale and existing infrastructure, increasing profitability.
Having honest conversations with franchisors to ensure there is potential to expand and identifying where there is a sufficient potential customer base and workable territory will be fundamental to those plans.
It is also key to build the business with an eye to an 'exit' at some point in the future – whether this be a sale to another franchisee, a buyback by the franchisor or a sale to an investor.
The franchise agreement will set out the procedures for the sale and what consents are needed from the franchisor. Where the proposed sale is to an unconnected party, the franchisor will wish to approve the proposed buyer and ensure that it meets its criteria for becoming a franchisee (including having the necessary finance in place to purchase and operate the business with sufficient working capital).
The exit can be structured either as a sale of the business and assets or the sale of the shares in the franchisee company. Unless significant investment values or multiple brands are involved, most sales take the form of an asset sale meaning that any liabilities of the franchisee business that are not expressly agreed to be taken on by the buyer remain with the seller. As a seller, it is important to factor into the sale price any fees and payments that need to be made to the franchisor.
To assist in making the sale process as smooth as possible, it is becoming more common for franchisors to provide a draft sale and purchase agreement for the parties to use. When reviewing that draft agreement, the seller should remember that:
- the draft will most likely contain restrictive covenants to prevent them from competing with the franchise business following the sale – a seller should not accept covenants that are more restrictive than those already given in favour of the franchisor under the franchise agreement;
- it may be asked to give training and support to the buyer for a period post-sale – the seller should be comfortable that it can meet those obligations; and
- the draft will contain warranties in favour of the buyer in respect of the franchise business – the seller should ensure that the warranties are not unusually onerous, that it has the ability to disclose any issues that would otherwise breach those warranties and that its liability under them is subject to the usual limitations that protect a seller.
Where the form of sale agreement is specified by the franchisor in advance, the seller’s ability at the point of sale to negotiate that agreement and include important limitations on its liability for any future claim will be more limited.
It is therefore critical that potential franchisees pay particular attention to the terms and requirements relating to an exit from the franchise. These provisions shouldn't be viewed as something to only think about years down the line – by which time significant value may have been created by the franchisee but partially lost through a lack of planning for the exit.