[EP 280] Franchising Tips, Tricks & Traps: Smart Tips for Selling Your Franchise Business

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Joanna Oakey [00:00:24]:
Hi, it’s Joanna Oakey here and welcome back to The Dealroom podcast, a podcast proudly brought to you by our commercial legal practice Aspect Legal. Now, in this chat, I’m joined by two of our very own legal eagles, Alan Prasad and Alex Carter. Now, in this episode, we dig into some of our own in-house wisdom. And in this episode, it is about franchising and in particular, franchise sales and acquisitions. In this episode, we are talking through franchise agreements in the context of sale and some of the things that should be top of mind for any franchisee looking to sell, and of course, for their deal team, too. We also step through leases and some of the implications of leases when a franchisee sells, both from seller and landlord perspectives and a host of other considerations that emerge in this fascinating discussion. Alan and Alexandra each have a wealth of expertise together, having dealt with hundreds of transactions relating to franchise businesses. So as you hear, it’s a case of one plus one equals three in this episode where we have Alan and Alex sharing their insights.

Joanna Oakey [00:01:50]:
So let’s get into it with Alexandra and Alan. Alan and Alex, welcome to The Dealroom podcast. It’s so good to have you on here today.

Alan Prasad [00:02:00]:
Thank you.

Alexandra Carter [00:02:00]:
Joy to be here, Jo.

Joanna Oakey [00:02:03]:
I’ve got you both here because you are our specialised deal team for our franchise business sales. And look, this is really an interesting area and I think fascinating because there are obviously franchises for a large proportion component of small businesses here in Australia. We specialise, of course, in the legal side of acquisitions and sales of businesses. And so, of course, franchising is a really key component of part of the work that we do and the sector that we deal with. So we thought it would be really good today to focus on some of these areas that are specific to franchising. This is part one. Part one. We’re talking about selling franchises.

Joanna Oakey [00:02:49]:
How about I start with you? What are some of the key things that you see that are different in the sale of a franchise business than your average business?

Alexandra Carter [00:03:01]:
Thanks, Jo. So every franchise will be subject to a franchise agreement that the seller had originally signed when they first purchased the franchise. And in that franchise agreement, there will be a process set out that they will need to follow when they are looking to sell the business. Or assign, transfer the business to a third party. And something that a lot of sellers don’t realise is that that agreement might actually contain a provision to say that the franchisor has a right of first refusal to buy the business back from the seller before they sell it to a third party. So there’s usually a timeframe associated with that as well. So the seller would actually have to make an offer to the franchisor to buy the business and allow them a certain amount of time to consider that offer and or reject it. So, for example, that could be one month, and then only once the franchisor confirms that they don’t wish to buy the business, is the seller actually free to sell it to a third party.

Joanna Oakey [00:04:02]:
And such an important point, isn’t it? Because obviously that impacts our timeframe of sales. If we’ve got sellers who aren’t aware of this and are trying to get into a sale environment, of course, which we see from time to time, the sellers find buyers and then they all want to move quickly, which we completely understand. Of course, that can be a little bit of a hiccup in the timeframe of the process if it’s not well understood from the beginning. So I think it’s a really good point. Alex and Alan, how about you? What are some of the top things that you see?

Alan Prasad [00:04:35]:
Look, in terms of selling a franchise? It’s very different from selling an ordinary business, as Alex has mentioned, that the first point of selling a franchise is to look at the franchise agreement to understand what is the process of transferring that business to or selling that business, or as we call it in franchise, assigning that business over to a buyer. The first right of refusal of the franchisor is usually where we start with, and if the franchisor does say that they do not want to purchase the business, then we can look at a third party to buy. But even more important is that the third party needs to be approved by the franchisor before that sale can even occur. So the difference between the usual process of buying a business to a franchise is that the franchisor is really quite a key party in this transaction that needs to first be given that first right of refusal. And secondly, if they’re not going ahead with the purchase of it, then they need to approve any buyer that the seller finds. And plus, not just that, there are various obligations of the seller under the franchise agreement in relation to, for example, they probably would have to pay the franchisor a fee, which is called an assignment fee, to sell the business to a third party, the approval process as well.

Joanna Oakey [00:06:03]:
So that’s a great point. So we’ve got timeline impacts. Obviously, we’ve got this first right of refusal, then we’ve got this whole approval process. We’ve got fees. It’s a lot to get your head around, aren’t there? And I know both of you have done a lot of work in the sale of franchise businesses. What’s some stories, what are some examples of things that you’ve seen where things haven’t exactly gone to plan that can perhaps be a little bit of a warning for some of our listeners who are heading down this path at the moment?

Alexandra Carter [00:06:34]:
Jo, I’m actually working on a matter at the moment where no one can locate the original franchise agreement that was signed.

Joanna Oakey [00:06:42]:
Oh, wow.

Alexandra Carter [00:06:43]:
That’s not ideal. But we have come up with a workaround, which is to simply get confirmation from the franchisor that the seller has followed the process that they require and that they do not wish to exercise their right of first refusal and that the seller is free to sell this business to a third party.

Joanna Oakey [00:07:05]:
Fascinating. I tell you what, isn’t that interesting? And you’d think it’s such an important document in a business. But I guess the thing is, it’s one of those things that when business owners purchase a business or enter into the franchise agreement, I guess this is one of those documents maybe they put in a bottom drawer and then is at risk of not coming out till either a, something goes wrong or b, they’re looking to sell. And if you can’t remember exactly which drawer that bottom drawer is, I guess you’ve got yourself a bit of a problem. But this is all about prep for sale as well, isn’t it? Making sure that you’re getting yourself ready in advance so that you’re not at the last minute scrambling, trying to find these documents. How about you, Alan? What have you?

Alan Prasad [00:07:46]:
That’s great. That happens quite, quite often, believe it or not. But, and also in addition to the franchise agreement, the seller must also prepare with the franchise organisation what’s called a disclosure statement, which provides all the information on the franchise apart from the store that is being sold, if it’s got a physical store or the business that is being sold. But what are the other franchise businesses that this franchise organisation has? So it’s quite a critical document that needs to be provided to a buyer. And under the, what also operates is what we call the franchise code of Conduct, which is a document that is more like a guideline that must be followed by a seller, by a franchise as well as a buyer in terms of the whole process of selling the business. So there’s a lot to consider as a seller. Other aspects that I have found. I’ve done over about 100 transactions in acting for sellers, franchise businesses, various businesses, but one of the key ones is also vetting any buyer that is coming in and offering to purchase your business to ensure that they would be approved by the franchise.

Alan Prasad [00:09:06]:
Also, then again, understanding what are the factors that the franchisor will consider when they need to approve a buyer. One of the main ones is their financial strength and experience in the industry in which the franchise business that has been sold is operating. But there are various other factors. But those will be the two main ones. And quite often I have seen deals falling because the franchise isn’t approving a buyer.

Joanna Oakey [00:09:36]:
How frustrating is it? It’s frustrating for all of us when deals fall over. But it’s particularly frustrating for these sellers who spend a lot of time, and can I just say, the brokers who are acting on behalf of the sellers in many instances, too. When you’ve prepped this business for sale, you’ve got it on the market, you’ve had a heap of buyers that you’ve vetted, you’ve ended up with a particular buy, and then you turn out that you’ve got someone that the franchisor won’t approve. Such a good point that you make, Alan, just to and I guess this is part of why we do these podcasts, to arm our sellers and buyers as well, with information about what the process is that they may not have realised in advance. So that when you’re vetting those buyers, you’re thinking about what the buyer would look like from the franchisor perspective as well. And I guess that is also relevant to a landlord’s perspective because we’ve got. This is the joy of franchise businesses. We have got a multitude of other stakeholders in the business.

Joanna Oakey [00:10:36]:
So not only do we have the franchisor, we also have the lessor. Alex, as our resident leasing expert, why don’t you talk to us a little bit about the leasing issues in a franchise business?

Alexandra Carter [00:10:49]:
Sure, Jo. There’s usually two ways in which a lease is structured in relation to a franchise business. So one of those ways is where the franchisee is simply a tenant of a premises, and then you’ve got a third party landlord, or the franchisor actually might be the tenant on the lease, and then they will grant a sublease to the franchisee. So that is a totally different structure. And both of those scenarios actually, most of the time result in the directors of the franchisee needing to provide personal guarantees to the lease, which is quite an onerous obligation. So that’s also something that buyers need to be really aware of when they enter into a franchise agreement, is realising how onerous that lease, and potentially for quite sometime in the future if the lease is a long lease.

Joanna Oakey [00:11:39]:
Such a good point. And how about you, Alan? Any interesting stories you’ve seen? When we are looking at the leasing side of selling a franchise business?

Alan Prasad [00:11:47]:
Look in terms of personal guarantees. Most of the leases, probably with most of the sale of the businesses that we have, that the buyer would need to provide a personal guarantee. But from a seller’s side, please make sure that you release, that the landlord releases you from the personal guarantees and you have a document in place that provides that. So a few times I have actually seen where lawyers acting for sellers have actually overlooked that process whereby the seller continues to be personally liable for leases that have been assigned, but they haven’t, or sorry, or even novated to a certain extent. So those are some of the key elements. Costs is another issue from a seller’s perspective to make sure that you understand that, you know, what are the landlords costs to approve the incoming franchisee? Who is going to be paying for those costs? Usually it’s the seller. And also what are the costs when you’re selling the business? From a franchisor’s perspective, what is the franchisor’s costs? What are the exit costs? Is it going to be a fixed cost that you’ll be paying to the franchise or is the franchise going to be charging you a percentage of the sale price? That happens too. So it’s really important as a seller to work with the franchisor to understand the approval process before they sell, before you sell your franchise and understand the lease.

Alan Prasad [00:13:17]:
There are times when even Alex, similar to not finding franchise agreements, so is unable to find the current lease.

Joanna Oakey [00:13:27]:
And that happens a lot, doesn’t it? Fascinating, isn’t it? As I said before, these do seem like important documents. However, they are one of those examples of documents that just aren’t used every day in the business, obviously. So if you’ve not had great record keeping back to day dot when you started, then these sorts of things can be a real issue. But of course they become really important. Not just because you need to understand the provisions of notice that you have to give on each of these agreements or whatever, what the process of assignment might be and fees are involved, and also because you need to provide it to the buyer as part of due diligence. Okay, look what a fabulous quick snapshot you’ve both given us. Thank you so much for coming on the show. Of course, for everyone who’s listening in, there’s a couple of things that you should know.

Joanna Oakey [00:14:18]:
We have lots and lots of information resources that we provide for our clients. Guide them through. If you come on board as a client of aspect legal, then you get all of that and obviously we hold your hand through the whole process and you’ll see some a link in the show notes for if you want to organise a call with our team, just have a bit of a chat about your business. If you’re looking at the potential of a future sale, you’re in a sale process right now and you found a buyer, or indeed if you’re a buyer and you want some great legal help, but we also have some information available for you even if you’re not at the point of becoming a client yet. We have a great download that you’ll find a link to in the show notes that will give you a whole lot of information about how to comply with the franchise code of conduct when you’re selling the business. So really important for you to understand what your obligations are and how you comply with them. So head over to the show notes and there you’ll find a link for the download for that if you are looking to sell your business at some point in the future. So Alex and Alan, I’ll throw to you now just for your parting thoughts for our listeners.

Joanna Oakey [00:15:29]:
Bearing in mind our listeners are also brokers and accountants who are advisors to our sellers of franchises. Alex, some parting words from you.

Alexandra Carter [00:15:39]:
Thanks, Jo. My parting words would be if you’re considering selling a franchise business, please make sure that you have all your documents in order and you can locate them. So that will be the original franchise agreement that you signed and also a copy of your lease, if there is one associated with the franchise. That’s really important for us to have as early as possible so we can make sure that we follow all the correct processes in those documents.

Joanna Oakey [00:16:06]:
Love it. Fantastic. Very good advice, Alex. And how about you, Alex?

Alan Prasad [00:16:10]:
Thanks, Jo. I suppose from a seller’s perspective it’s an exciting journey to be because you have already been in the franchise process and ingrained into that and now you’re passing on the pattern. As such. One of the most important relationships, in my view, that you as a seller should have is a really close one with the franchise, particularly in terms of making sure that any of the reps of the franchise reps that come in to see in your process procedures and the way in which you run your business, that’s quite open and transparent. And secondly, that you, working with a franchise, understand what is the process of exiting a franchise because it’s one of those businesses which actually has a process of an exit, a succession plan. So making sure that you understand that and comply with that process as well.

Joanna Oakey [00:16:58]:
Love it, Alan. Well, Alan and Alex, once again, huge thank you for coming onto the show. Thank you, our listeners, for listening in. Hopefully you got a lot of information out of that. And don’t forget to go and download your little cheat sheet or set up a call with Alex, Alan or any one of our other fantastic franchising team here at Aspect Legal. If you were thinking of selling, buying vising a franchise sale. Thanks a lot, guys.

Alexandra Carter [00:17:25]:
Thanks, Jo.

Alan Prasad [00:17:26]:
Thank you, Jo.