For many potential franchise owners, one of the avenues for purchasing a franchise may be to buy an existing franchise. This may bring numerous advantages, for example, it may allow you to continue operating the business with ongoing goodwill. It may also allow you to avoid the process of finding and fitting out the appropriate premises to run the franchise. Although the purchase of an existing franchise may bring benefits, it does not come without risks. To aid you in mitigating the risks, here are a few tips for purchasing an existing franchise.
1. Do Your Due Diligence
Due diligence is an essential step to purchasing a franchise. The process for due diligence involves not only investigating the operation of the business, but also the operation of the franchise. Here you might not only be looking at the earnings information of the business in the last financial year but also investigating the market position of the franchisor and their franchise system. The due diligence of an existing franchise requires double the amount of work from a standard business purchase, and so you should keep this in mind when starting the process.
2. Determine Whether Franchisor Approval is Required
Usually, in franchise systems, the owner of the business cannot simply transfer the franchise without the approval of the franchisor. It is useful to make appropriate enquiries with the seller, or if you have direct contact, with the franchisor, to determine what criteria (if any) you need to fulfil to be able to enter the franchise system. Often, this may include having prior business experience or being of good financial standing. Therefore, you should be ready to provide information such as details of your financial information or business references.
3. Determine How the Franchise will be Transferred
The purchase of an existing franchise business may occur in various ways, and so you should seek direct clarification from the franchisor. Transfer via the franchise agreement is one way in which the transfer of a franchise can occur. This usually means that the terms and conditions of the franchise agreement will remain the same, which may mean that the term of the franchise is less than the agreement stipulates, e.g. the three remaining years of a five-year term.
Another possibility for transfer is via signing a new franchise agreement with the franchisor. This may allow for a longer term, but the franchisor may include other new terms and conditions in the franchise agreement, so you should thoroughly check this. You should also be wary that some representation the seller makes regarding the franchise may no longer apply as you are entering into a different franchise agreement.
4. If there is a Premises, Review the Terms of the Lease or Licence
If the franchise you wish to purchase is connected to a premises, you should determine:
- how you will obtain the right to occupy the premises (e.g. will you enter the lease yourself or do you have permission to occupy via a licence from the franchisor?) and,
- whether the right to occupy matches the term of the franchise agreement.
Ideally, the term of the lease and franchise agreement should correspond with each other to avoid the need to relocate during the term of the franchise agreement or the need to assign your lease/ licence if the franchise agreement comes to an end before expiry of the lease/ licence. You should not only be looking at the length of the lease/ licence but also at its terms and conditions, especially in regards to:
- a make good obligation,
- undertaking refurbishments,
- the possibility to renew, and
- commercial obligations.
You should undertake a thorough inspection of the legal documents as well as to the condition of the premises.
5. Review Market Position
This tip flows on from the first obligation relating to undertaking due diligence. As part of such due diligence, you should review the market position of the franchise business and determine the reasons as to why the seller is selling the business. It could be that the seller may simply be moving on to other business endeavours. However, if the business hasn’t been performing well, an analysis of the market position may provide insight into determining whether there are potential issues with the franchisor’s products, services or system.
6. Check What the Sale Includes
You should undertake an analysis of the commercial details of the sale. Therefore, you should know what exactly the purchase of the business includes. In the case of most franchise transfers, there is no need to pay the “initial franchise fee” as the purchase of the business includes the fee. Here, it is essential to differentiate between the commercial obligations owed to the seller and the commercial obligations owed to the franchisor to ensure that there is no possibility of a double-up.
7. Review Business Purchase Terms
The purchase of a franchise business requires that you enter into at least two contractual obligations:
- with the franchisor, and
- with the seller of the business.
Often some of these obligations may intertwine. As important as it is to review the franchise system, it is also important to review the terms and conditions of the purchase of the business. This includes determining whether you will be taking over employees, checking over the conditions of the assets or seeing whether the seller will provide certain warranties and guarantees. Such obligations may intertwine if, for example, you were to take over an employment contract for an employee that is the manager. You may need to ensure that the franchisor approves of the manager in case the franchisor includes this obligation in the franchise agreement.
The purchase of an existing franchise agreement comes with certain benefits, but also comes risks. Any potential purchaser of an existing franchise should review not only the franchise, but also the business, before proceeding with the purchase. Doing so helps to minimise the risks when entering the franchise and ensures that you are aware of the standard and condition of the business before your purchase. If you have any questions or need advice before purchasing an existing franchise, contact LegalVision’s franchise lawyers on 1300 544 755.
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