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When selling your franchise business, you must conduct due diligence. Due diligence lets prospective franchisees know what they are committing to before buying into a franchise. Although the purchaser will conduct some due diligence of their own, as a franchisor conducting due diligence will be essential to drafting your franchise disclosure document as per the Franchising Code of Conduct (the Code). This article explains three mistakes you should avoid when conducting due diligence to avoid falling short of your obligations.
This factsheet sets out the three key financial disclosure obligations every franchisor needs to comply with.
Misunderstanding Due Diligence
Due diligence is an investigatory process that enables potential franchisees to understand how your business operates. For this reason, your due diligence should include:
- financial due diligence; and
- legal due diligence.
Financial Due Diligence
Financial due diligence will involve confirming the:
- profitability of your business;
- revenue of your business; and
- prospects of your business’ future growth.
If you operate an existing franchise, you will likely have a record of the franchise’s historical trading data. For example, you might already keep track of the volume of customers or sales to calculate the total franchise fees payable. Given that this data will be specific to the franchise’s location, it can be invaluable to potential franchisees when considering whether or not to buy into the franchise.
Legal Due Diligence
Legal due diligence will involve you:
- confirming the transferable assets of the business; and
- assessing whether there are any legal risks or issues.
A prospective franchisee is entitled to an information statement that identifies some of the standard risks and rewards they should consider before becoming a franchisee. For example, franchisees may be liable to pay some unexpected expenses under the franchise agreement. In this sense, prospective franchisees should know that the franchise agreement will usually incorporate strict performance standards that determine how you conduct your business.
Not Preparing Your Documents
A potential franchisee may have a due diligence checklist they want to check off gradually. This will allow franchisees to gauge how well your business is operating. For this reason, you should prepare the correct documents concerning the following.
Company Structure
It would help if you clarified who holds your business’ assets and where they are. Business assets will include your:
- intellectual property (such as your trade marks);
- leases; and
- franchise agreements.
Since ownership is not always clear in a company structure, you should set out and simplify the ownership of business assets at the earliest stage possible. This way, you can ensure issues regarding ownership do not impact the sale from going ahead.
Staff
You will also need to create a list of your staff in the business. Importantly, you should decide whether you want the potential franchisee to retain the staff. If so, you need to clarify whether your franchisee must pay staff entitlements before the sale or transfer them to the purchaser as a discount on the purchase price. In any event, it would be wise to obtain legal advice when dealing with staff entitlements to ensure employees receive the correct amount.
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Forgetting to Use Non-Disclosure Agreements
A prospective purchaser must also sign a non-disclosure or confidentiality agreement before accessing your business information. A non-disclosure agreement (NDA) is a legally binding agreement that prevents prospective franchisees from leaking commercially sensitive information to others. For example, suppose a potential franchisee discloses any of your business’s confidential information. In that case, you may have contractual remedies available to compensate your business for any loss due to the breach.
Without an NDA, you risk potential franchisees misusing your business’ confidential information without legal remedies available to you. In this sense, an NDA can be essential to maintaining your franchise system’s competitive edge and preserving its confidential information.
Key Takeaways
Due diligence is an investigatory process that enables potential franchisees to understand how your business operates. To ensure you make proper disclosure, you must:
- understand the scope of due diligence;
- have your documents prepared; and
- use non-disclosure agreements to prevent potential franchisees from leaking your business’ confidential information.
If you have questions about due diligence, our experienced franchising lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
Due diligence is an investigatory process that enables potential franchisees to understand how your business operates.
Franchisors must conduct due diligence to prepare certain documents, such as the disclosure document and information statement. Additionally, potential franchisees are likely to conduct their due diligence to decide whether or not to purchase a franchise.
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