Key considerations when buying a franchise

Why it's important to do your research if you are looking to buy a franchise, by Ed Savory.

coffee shop laptopMany new franchisees are opting to buy existing franchises (franchise re-sales). As the volume of franchise re-sales continues to increase, and the market in the UK matures, the processes being put in place by franchisors are improving, but there are some key considerations that any potential franchise buyer should be aware of.

Do your due diligence

As well as the standard financial and legal due diligence that any buyer should carry out on a business it is proposing to buy, in the context of franchise re-sales, you should make sure you understand why the franchise is for sale.

Is the seller in material default of its franchise agreement, and therefore being forced to sell? Is the seller retiring and looking to cash in on their hard work? Or is there some other rationale behind the re-sale?

Are you buying the business/assets or the shares/company?

Many sellers will prefer to sell their company (rather than just the business/assets) for tax reasons, as the seller of a company will, in all likelihood, qualify for entrepreneurs' relief and reduce their capital gains tax liability. Indeed, re-sales in certain sectors are almost always carried out by a company sale – for example, in the care sector, where the company will have (and the buyer will want to retain) the Care Quality Commission (CQC) registration.

If you are buying the company (or, more accurately, the shares in the company), you are getting it warts and all. In other words, once you own the company, you will have acquired all of its assets, together with its liabilities. Therefore, buyers need to ensure that they carry out a thorough due diligence process, with appropriate warranties and indemnities in the share purchase agreement.

If you are buying the business/assets, you will only acquire what you expressly agree to acquire, which should be less risky (though not always).

Understand that there are at least two, and perhaps three, distinct transactions

In buying an existing franchise, the buyer is entering into two distinct transactions:

  • a sale and purchase agreement with the selling franchisee
  • a franchise agreement with the franchisor

If there is a premises involved, then there may be a third element of a lease with a landlord.

In general terms, the franchisor’s interests will be aligned with the buyer. Therefore, the franchisor will have a vested interest in facilitating a smooth and swift process, and quite often, the franchisor will issue a standard form re-sale agreement. However, this may not include all the provisions that a prudent buyer will require. The parties should be free to negotiate the terms as they require (providing the franchisor's rights are not prejudiced).

Be clear about the basis of the purchase price

Typically, a franchise is marketed for sale at a price based on the turnover. This is unlike most other non-franchising business acquisitions, where the purchase price relates to profitability, often by reference to earnings before interest, tax, depreciation and amortization (EBITDA), or some variation thereof.

A buyer needs to make sure that they have run the numbers, and are confident and comfortable with the potential financial performance of the franchise. Moreover, the payment structure may need to include some element of deferred payment(s) to protect the buyer if the customer base of the target franchise proves to be worth less than was promised by the seller.

Get the right advice

All parties to a franchise re-sale should make sure that they are being advised by a solicitor with experience in both franchising and business purchases. Details of suitably qualified solicitors can be found on the BFA website.

About the author

Ed Savory is a legal director and head of franchising at Birketts, @birkettsllp.

An experienced franchise and corporate lawyer, who has advised on numerous franchise re-sales, acting for buyers, sellers and franchisors, Ed is also a qualified franchise professional under the British Franchise Association.