First of all, we wish you a Happy and Wonderful Year 2021. It should not be too difficult for 2021 to be a better year than 2020.
This first Fasken Franchising Bulletin for 2021 addresses a question that most franchisees and several new franchisors are asking themselves: Why can't a franchisee sell her or his business to whomever she or he wants for the highest price she or he can get?
This question highlights one of the important differences between, on one side, the individual interests of a franchisee and, on the other side, the interests of the franchisor and, more importantly, the interests of a franchise system as a whole.
Indeed, it is perfectly normal for a franchisee to want to make the best profit, or gain, at the time of the sale of her or his franchised business.
Except in cases of family or employee succession, the franchisee's main concerns at the time of the sale of her or his business are (i) to obtain the highest possible price and (ii) to find a buyer willing and financially capable of paying that price.
The franchisor, however, has some other interests that are equally important to the franchisor and, more importantly, to the franchise network as a whole, including:
1. Preserving and protecting the network’s reputation:
A franchisor has not only the right, but also the obligation, to preserve and protect the reputation of its network, both towards its competitors and towards delinquent franchisees.
To achieve this objective, the franchisor must therefore ensure that any new franchisee, including any purchaser of an existing franchised business, meets high standards, particularly in terms of personal, business and financial reputation.
For example, a franchisor does not want to end up with a franchisee who, for example, has been convicted of a serious crime or is being prosecuted for a significant tax fraud.
The franchisor must also ensure that any new franchisee does not have interests that conflict with those of the network (for example, an interest in a competing business).
2. Ensuring the continuity of the network:
Beyond its reputation, a franchisor must also preserve the values, culture and sustainability of its network.
In order to do so, a franchisor has established various criteria and a process for selecting new franchisees to ensure that new franchisees will properly operate their franchised businesses and make a positive contribution to the management, growth and evolution of the franchise network.
A franchisor is therefore committed to ensuring that any new franchisee in the network, including any purchaser of an existing franchised business, meets its criteria for selecting new franchisees and successfully completes the selection and training process for any new franchisee.
On another level, also to ensure the continuity of its network, a franchisor wants to avoid that a franchised business of the network leaves, through a sale, the franchise network to pass into the hands of a competing business or of a non-franchised entrepreneur.
Indeed, since the franchised business has developed its clientele under the network banner, and its customers have become familiar with the franchised business and its location under the network banner, the franchisor also wants to avoid that the goodwill of a franchised business in its network be, in some way, diverted to the benefit of non-franchised persons, particularly following the sale of the franchised business.
3. Relying on strong, high-performing franchisees:
Compared to the selling franchisee, unless the she or he already has significant assets (which is rarely the case), the purchaser of a franchised business begins as a franchisee with new significant debt: the portion of the purchase price that has not been paid in cash.
This is in addition to the fact that this new purchasing franchisee does not have the same experience as the selling franchisee, which makes it possible, among other things, that, at least for the first few months following the sale, her or his management of the acquired franchised business may not be as efficient and may result in higher costs than before.
In order to prevent its new franchisee buyer from quickly finding herself or himself in a difficult financial situation, the franchisor must therefore ensure that the buyer has sufficient financial resources to, at the very least, meet the following financial obligations: (i) pay the purchase price in accordance with the terms agreed to with the seller (ii) pay the fees and expenses inherent in the process of purchasing the franchised business (iii) have sufficient working capital in the franchised business to properly maintain its operations (taking into account the additional costs and risks resulting from the change in ownership and management), and (iv) make and pay for, in a timely manner, any investments that may be required under the franchise agreement (including any renovations, changes or additions to the franchise business).
4. Ensuring that its network’s franchised businesses offer their owners a reasonable prospect of profitability:
Beyond the capacity and financial resources of the buyer of a franchised business, another concern of any franchisor is the prospect of profitability of that business for its buyer.
The franchisor will therefore want to ensure that the price and terms of purchase of the franchised business leave the buyer a reasonable prospect of profitability and return on investment in order to avoid potential discouragement or undue weakening of the franchised business as a result of its sale.
5. Avoiding the risk that a franchised business may subsequently end up in the hands of persons not chosen or previously accepted by the franchisor:
Another important concern of the franchisor is to prevent the risk that, as a result of agreements entered into at the time of the sale of the franchised business (such as financing arrangements and security interests on the franchisee's shares or on the franchised business assets), the franchised business may later find itself in the hands of a person not previously approved by the franchisor, such as a creditor, a trustee or a person who acquired the business as a result of the exercise of a security interest.
To this end, many franchisors require that financing for the purchase of a franchised business be provided only from the resources of the purchaser and, if borrowing(s) is required, from financing obtained from recognized financial institutions and not from the seller, an individual, a private corporation or a non-institutional lender.
As with many other aspects of the franchisor-franchisee relationship, in the event of the sale of a franchised business, the interests of the franchise network as a whole must outweigh the individual interests of the selling franchisee, which in most cases, however, does not preclude the selling franchisee from selling her or his franchised business at a reasonable price and on reasonable conditions.
Fasken has all the expertise and resources to help you draft agreements that are complete, appropriate and that protect your rights, while avoiding potential pitfalls.