Owning a franchised business can present a lucrative opportunity, and this is especially true when acquiring a franchise with a history of success and/or an opportunity for growth. While each franchise system is different and carries its own set of complexities, there are generally three fundamental issues that every potential franchise owner should consider when pursuing the acquisition of an existing franchise location or opening a new location.
Formation of an Operating Entity. Operating any business in your personal capacity is fraught with problems and puts your personal assets at risk. Any potential franchisee should consider forming a business entity – often a limited liability company – to operate the franchise. In some cases, the franchisor may require the individual franchisee to sign the franchise agreement in his/her personal capacity, but would permit the franchisee to assign the operations of the franchise to the entity. We strongly encourage franchisees to form an entity before any acquisition is completed or even before any letter of intent is signed.
Obtaining Financing for the Acquisition. Aspiring franchisees may not have the liquidity to acquire a franchise with a lump sum cash payment. Engaging any potential lenders early in the process is essential. It is important to remember that, in most cases, the lender will require a personal guaranty of the individual franchisee. Banks may be willing to loan for the purchase price for a franchise, but will not provide working capital to cover initial startup expenses. Franchisees should be very aware of the cash flow of the franchise location, and any issues that might impact cash flow, such as seasonality. Many times an existing franchisee’s financial records may be lacking or incomplete, and it is important to complete your financial due diligence with the assistance of your advisors.
Real Estate. In the acquisition, the lease agreement governing the physical location of the franchise is a key component to the deal. Most franchisees are tenants in a space owned by a third-party landlord. Review of the existing lease agreement is another vital part of the due diligence process. The lease agreement will have a number of financial terms separate and apart from rent payment and it is important to understand those issues before seeking to transfer the lease as part of the acquisition. The landlord will likely need to consent to transfer the lease agreement to the new franchisee or may require the new franchisee to sign a new lease. Having the deal in place with the landlord should be a necessary condition to the acquisition of any existing franchise.
Developing a strategy with regard to these issues is a good first step toward a successful franchise acquisition. Please feel free to contact me for more information.