Purchasing any franchise business is a complex process. But, if you are purchasing an existing franchise, there are some important legal steps to take before you commit. This article will outline the key legal considerations to think about when purchasing an existing franchise.
Stage 1: Due Diligence
When purchasing a franchise, completing your due diligence is an essential step. Due diligence is the process of checking that a business’ operations, financials and legals are sound. Before you purchase a franchise, franchisors must disclose certain information about the business. You should also request copies of the existing franchise agreement and previous disclosure document from the seller. Ensure that you investigate the operations of the franchise network as a whole as well as the individual franchise you are interested in.
A good way to understand the business is to speak with the current franchisees. You should ask for the profit and loss statements for the business and seek financial advice on the franchise’s earnings and market position.
The legal side of your due diligence will involve:
- confirming which assets are to be transferred;
- assessing any risks involved in the transaction; and
- reviewing all important legal documents.
Stage 2: Reviewing the Sale of Business Agreement
After you have agreed upon the key commercial terms with the seller (i.e. the current franchisee you are buying the franchise from), the seller’s lawyer will prepare a sale of business agreement. This agreement outlines exactly what the sale includes.
Typically, at this stage, the seller will inform the franchisor of the sale. This is an important step because the franchisor may wish to interview you before they approve you as a franchisee. The franchisor also has the first right of refusal, which means that the franchisor has the opportunity to buy the business upon the same terms being offered to you. You should ensure that the franchisor waives this right before you spend money reviewing or signing the contract.
Once you receive the draft contract, carefully review it so that you understand your rights and obligations before you commit. Generally, the sale contract will include special conditions. These special conditions may state that:
- the sale is conditional upon there being a franchise agreement in place;
- the execution of the sale contract is conditional upon the seller satisfying all conditions under the franchise agreement (for example, paying any franchise fees);
- certain obligations must be performed (for example, providing a set level of training); and
- the franchisor must provide you with new equipment, or alternatively, you must purchase existing equipment from the seller.
Stage 3: Reviewing the Franchise Documents
The next important step is receiving and reviewing your franchise documents. You should have received the existing franchise documentation from the seller before signing the business sale contract as part of your due diligence. You should then receive your new franchise documents from the franchisor after signing the business sale contract and at least 14 days before the settlement date. The settlement date is when the sale is finalised.
You should also ensure you understand the franchisor’s approval process and check when and how you will need to complete any training. If you fail to check the approval process, you could pay the purchase price and then find that the franchisor refuses you as a franchisee. You need to make sure you are confident of approval before finalising the sale.
Unlike the sale contract, you exchange the franchise documents with the franchisor directly. Under the law, franchisors must provide:
- the franchise agreement;
- a disclosure document; and
- any financial information necessary for you to make an informed decision.
Make sure you understand what your franchise agreement and disclosure document include before entering into the agreement.
Usually, you will receive brand new franchise documents and start a new franchise term. However, in some circumstances, the franchisor may require that:
- you are assigned to the existing franchise agreement; or
- a new franchise grant is issued for the remaining term.
This means that you will only have the remaining term left under the seller’s agreement.
In most franchise arrangements you will also receive some initial training. When you are purchasing an existing franchise, either the current franchisee or the franchisor will provide the required training.
Stage 4: Reviewing the Lease Documents
If the franchise operates out of leased premises, the landlord will need to either:
- assign the current lease to you; or
- grant you a new lease.
In some instances, the franchisor will be named on the lease (the ‘head lease’), and you will be granted a sub-lease or licence to occupy the premises. Whatever the case, you should have the lease agreement reviewed by a solicitor. As a tenant, sub-tenant or licensee, you should find out:
- the terms of the lease;
- what your obligations are when occupying the premises;
- whether the term of the franchise agreement depends on the term of the lease; and
- if there are any options to renew the lease, sublease or licence.
Stage 4: Contract Negotiation
When you review your sale of business agreement, franchise agreement and lease agreement, you will have the opportunity to negotiate the terms of these agreements. As your lawyer reviews each document, they should prepare a table of amendments or note any proposed changes on the contract. Your lawyer will then send these amendments to the:
- seller’s lawyer;
- franchisor’s lawyer; or
- landlord’s lawyer.
You should carefully review any changes to the contract to ensure you understand your obligations or any ongoing rights and liabilities.
Stage 5: Exchange and Settlement
The final stage involves exchanging the key documents and completing the conditions of settlement as set out in the sale contract. This process is complex in a standard business sale and there are even more considerations in the sale of a franchise business. Therefore, it is important that you complete settlement exactly as the contract sets out.
If you are buying a franchise, there are many considerations to keep in mind. Before purchasing an existing franchise, you should carefully review all of the necessary legal documents and conduct your due diligence on the business. Ask for copies of existing documents from the seller as well as the new documents you receive from the franchisor. Make sure you negotiate any necessary changes to your contracts and fully understand the contents of your franchise agreement before you commit to the purchase. If you have any questions about purchasing a franchise, call LegalVision’s franchise lawyers on 1300 544 755 or fill out the form on this page.
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