A franchise buy back occurs when you, as the franchisee, are looking to leave the system but cannot find a purchaser. The franchisor always has the option (under the franchise agreement) to buy back the assets of the business. A franchise buy back will usually occur in two situations:
- the agreement has come to an end; or
- there has been a breach and the franchisor wants to terminate the franchise agreement and buy back the equipment.
The article will explain how to prevent or make the most of a buy back if it occurs.
What’s a Breach and Termination?
A breach occurs when a franchisee fails to do something specified in the franchise agreement. If you have breached a term of the franchise agreement, the franchisor must issue you with a formal breach notice if they intend to end the agreement. This should not be taken lightly, as a failure to remedy the breach can result in the termination of your agreement.
The notice must set out the:
- franchisor’s intention to terminate the agreement;
- steps to remedy the breach; and
- time you have to fix the breach.
The franchisor is required to give you a reasonable amount of time to remedy the breach. However, this is not a defined term. The Franchising Code of Conduct states that a reasonable amount of time is usually a month or less. After the expiry of this time, they can issue you with a termination notice.
Selling Your Franchise
Under the Code, the franchisor cannot unreasonably stop you from selling your franchise. However, selling your franchise may become increasingly difficult if the franchise continues to lose money. If your franchise is starting to fail, you should consider selling it early. This will be more attractive to purchasers compared to a business that has been failing for a long time.
If you have been issued a breach notice and you intend to sell it, you should do everything in your power to remedy the breach and prepare for sale. Otherwise, the alternative may be the termination of your franchise. If the franchisor terminates your agreement, you will lose your right to sell the franchise. In this period, the offer you receive may be very low.
However, you should consider all offers as you will likely get less in a buy back.
If Your Franchise Agreement Has Been Terminated
Lease or Licence
In terms of your lease, you will either:
- hold the lease; or
- the franchisor will hold the lease and you will have a sublease or licence.
If the franchisor holds the lease, they have a lot more power as it allows them to remove you from the premises once the agreement has come to an end. They will be more likely to initiate a buy back if they hold the lease as they can simply terminate you and potentially continue to operate the business. However, they will have to compensate you for the equipment.
If you have a lease directly with the landlord, the lease may require you to assign it to the landlord if they request this. However, if the landlord declines to assign it, you may be able to retain the store. This may give you the option to debrand and begin operating the same or a different business.
However, you should consider the restraint of trade provision in the franchise agreement. The franchisor may be able to enforce the restraint of trade in court which would prevent you from running the business. It is also important to state that the lease may set out that the location has to be returned to the original state. This means you would have to remove the fitout, which can be costly.
One of the main assets of your business during a buy back is the equipment. The franchisor may want to buy back the equipment for a number of reasons.
Firstly, the franchisor may want the equipment to start the franchise in that location or a separate location.
Secondly, the franchisor may wish to stop you or a competitor from opening up a competing business.
Most franchise agreements set out that franchisors have first right of refusal. This means franchisors have the right to purchase the assets or prevent the franchisee selling them to another person.
If you do not have any other offers, the franchisor will only have to purchase the equipment from you for the written down value. An easy way to calculate this value is to take the price you paid for the equipment, minus the depreciation. Almost all businesses will write off the value of the equipment for tax purposes.
For example, if you purchased the equipment four years ago for $100,000 and claim that it has depreciated $20,000 every year, they will only need to pay you $20,000.
You should read these provisions carefully. If you are unhappy with the valuation, you should appeal in accordance with the provisions in your franchise agreement. This may include an appeal to an independent valuer.
Another aspect of a buy back is the stock that you have on hand in the event of a termination. If a franchisor terminates the agreement they will not need to purchase back this stock. Therefore, it is important to try and sell all of the stock before your agreement is terminated. Once terminated, restraints of trade may also prohibit you selling the stock.
Overall, if your franchise is not doing well, it may be time to consider selling the business. It is important to consider this option early as the longer the business fails, the less attractive it will be to potential purchasers.
If you have been issued with a breach notice, this should be taken seriously as failure to remedy the breach can give rise to termination and the loss of ability to sell the business. The equipment will form the bulk of the buy back and it is important to understand that the franchisor will only have to pay you the written down value of the equipment.
If you would like to learn more about buy backs, get in touch with LegalVision’s franchise lawyers on 1300 544 755 or fill out the form below.
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