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TEN THINGS YOU SHOULD KNOW WHEN BUYING AN EXISTING FRANCHISE BUSINESS

By R. Scott Caulkins, Esq.

The typical path to becoming a franchisee is to sign a franchise agreement with a franchisor and open up a new franchise location. In a new, start-up franchise system, this is likely to be the only path to becoming a franchisee. But in an established franchise system with many existing franchisees, you may have an opportunity to become a franchisee by purchasing the business of an existing franchisee. If you are considering purchasing a franchise from an existing franchisee, here are 10 things unique to buying a franchise business that you should know:

1. Why is the franchisee selling the business? This question is important no matter what business you are buying. But if it is an existing franchise business, there is more to be concerned about than the financial condition of the business (which you can find out about by obtaining financial records). The business may be making money, but the seller may want to sell because of problems with the franchisor or concerns about the franchise system.

2. Talk to other franchisees about their satisfaction with the franchisor and franchise system. Unlike the franchisee with whom you are negotiating, other franchisees are not trying to sell a business to you and may be more forthcoming in disclosing concerns they have about the franchisor or the franchise system. Also, this provides an early opportunity to begin building relationships with people who may be your fellow franchisees.

3. Even though you are buying an existing business, the franchisor will need to approve the sale. Usually this means that the franchisor will want you to submit financial and other background information demonstrating that you can afford to buy the business on the terms you negotiate and that you satisfy the standards that the franchisor imposes on new franchisees.

4. You will either be assigned the existing franchise agreement of the seller or the franchisor will require that you sign a new franchise agreement, which may have different terms and conditions. In either case, it is important for you to carefully review and fully understand the franchise agreement that you will be required to sign. A franchise lawyer can advise you regarding the terms of the franchise agreement and help you in negotiations with the franchisor.

5. Depending on whether you will be required to sign a new franchise agreement and other circumstances of the sale, the franchisor may be required by federal and state law to give you a Franchise Disclosure Document (often referred to as an FDD). The law requires this important document to be delivered to prospective franchisees for their protection. A franchise attorney can advise you regarding your right to receive an FDD. In the FDD the franchisor is required to disclose detailed information about the franchisor’s background, the franchise system and franchise relationship. Because the contents of the FDD may have a significant impact on your purchasing decision, the sooner in the process you have this document the better.

6. If you are buying a franchise that has a lease for an existing office or retail location (as opposed to a home based franchise business), you will likely need to either get landlord approval for the assignment of the lease or negotiate new lease terms. Generally you will want the lease term to match the term of your franchise agreement. Unlike a typical lease assignment when a business is purchased, if new terms for the lease are negotiated with the landlord the franchisor will most likely have the right to approve the new lease terms and may require specific provisions in the lease allowing the franchisor to take over the lease if you default under the franchise agreement.

7. As a condition for approval of the assignment of the existing franchise business, the franchisor may have the right to require that the franchise location be updated to meet current standards for signage, furnishings, equipment and other items relating to the overall appearance of the business (particularly if the franchise is a retail business). This can be expensive and, as the buyer, you will need to account for these expenses in your business plan.

8. There are often other fees related to the purchase that are unique to franchise businesses. For example, franchisors often charge a transfer fee which must be paid, either by the buyer or seller, as a condition of the franchisor’s approval of the transfer. Also, the franchisor will probably require the new owner(s) and manager(s) to successfully complete a training program before taking over the franchise business. There are typically fees and travel costs associated with the training program.

9. Most franchise agreements require a franchisee or its owners (if the franchisee is a company) to personally guaranty all the obligations under the franchise agreement. The franchisee’s spouse or the owners’ spouses may also be required to sign personal guarantees. This may affect your purchase decision or the willingness of others to invest money in the franchise business in exchange for an ownership interest.

10. Once you purchase on ongoing franchise business, you will likely be obligated to pay the franchisor “royalty” and “marketing fund” fees and possibly other fees. These fees are often based on a percentage of your gross revenues or some other formula described in the franchise agreement. In addition to being aware of these fees and factoring them into your business plan, you should ask the seller and other franchisees about the impact of the fees on the profitability of their business and the level of advertising and other support they receive from the franchisor in exchange.

Because the purchase of an existing franchise business involves unique issues, you should consider consulting with a lawyer that has experience with the purchase and sale of franchise businesses. Over the years, our lawyers have represented sellers and buyers in connection with the purchase of existing franchise businesses. As a consequence, we know what issues the sellers and buyers of franchise businesses confront and can provide advice on how to address them in the sale process.

If you would like to learn more about buying an existing franchise business, please contact Caulkins & Bruce, PC to schedule a consultation.

The information presented here should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

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