In the first of our series of articles looking at the franchise industry, we are taking a look at the key principles of ethical franchising and how franchisees should be able to realise the value of their business on a transfer.
It is a common misconception that a franchise network with a high level of resales is a bad sign. In fact, a healthy resale market is a good sign. It means that franchisees are able to build up profitable businesses which can be sold to recover a return on their initial investment and a constant influx of new franchisees means that the network is not stagnant - new, keen and eager franchisees bring with them fresh ideas and motivation.
A well drafted franchise agreement will give the franchisor the right to require its franchisees to follow its procedure on resales and to use the franchisor's standard documentation. In our experience, very few franchisors take advantage of such provisions, but it really can be worthwhile, not only for the franchisor, but also for the outgoing and incoming franchisees.
The main benefits of the franchisor being involved in the resale process (which includes instructing its own lawyers to draft the sale and purchase agreement and to deal with the resale on its behalf) are:
- the franchisor's financial interests are protected. By collecting funds on completion, the franchisor's lawyers can ensure that any monies which are due to the franchisor are paid out of the sale proceeds immediately following completion;
- the franchisor's lawyers can ensure that the outgoing franchisee's franchise agreement is terminated and that the incoming franchisee enters into a new franchise agreement on completion.
By adopting a sale and purchase agreement to which the franchisor is a party and instructing its lawyers to deal with the transaction, franchisors can remain involved in the process without any hassle. The franchisor's sale and purchase agreement should be fair to both the outgoing and incoming franchisees which means that their legal costs tend to be lower as a consequence of the franchisor's and it's lawyer's involvement since the amount of negotiation which is required is less - the parties start from a position which is closer together rather than being heavily weighted in favour of one party.
The process is a straightforward one.
- Once the outgoing and incoming franchisees are happy that an agreement for sale has been reached in principle and the franchisor has approved the incoming franchisee, that is the point at which the franchisor's lawyer should be instructed and their involvement will begin. Ordinarily, the franchisor's lawyer's involvement will be at no cost to the franchisor (subject to the provisions of its franchise agreement) since those costs will be split equally between the outgoing and incoming franchisee.
- At that stage the franchisor's lawyer will draft the sale and purchase agreement and franchise agreement and issue those to the parties or their lawyers, as the case may be.
- They then liaise with both sides to ensure that the negotiations are progressing in line with the agreed timescales.
- Once the outgoing and incoming franchisees have agreed amendments to the sale and purchase agreement, the franchisor's lawyer will review all such proposed amendments and report to the franchisor, setting out what amendments the parties propose to make, how those amendments affect the franchisor and their recommendations as to whether or not the franchisor should accept such amendments.
- The franchisor's lawyer will then prepare final copies of the sale and purchase agreement, issue documents for signing to all parties and guide the parties through exchange and completion.
In terms of timings, ideally, exchange of the sale and purchase agreement should take place prior to the incoming franchisee commencing their training with the franchisor. On exchange, the sale and purchase agreement becomes binding on all parties and, usually, the initial franchise fee and a deposit equal to 10% of the purchase price are payable by the incoming franchisee. Completion would then take place at a time to suit the parties after satisfactory completion of the training course.
In our experience it is a no brainer that the franchisor should be involved in the resale process. The key is for the franchisor to get involved at the very beginning and to take control of the transaction by educating its franchisees and implementing a streamlined process which deals with the procedure from the franchisee deciding it wants to sell, to completion and then on-boarding of the new franchisee.