I will continue our series on topics discussed at the ABA Forum on Franchising by examining Franchisor Mergers and Acquisitions (M&A). As we learned at the ABA Forum on Franchising, sales and purchases of Franchise Systems are alive and well, even with the ongoing pandemic.
These deals can take many forms. In some transactions, the Buyer may be a private equity firm whose goal in purchasing the Franchise System is to help grow the system and eventually sell for a profit. In others, the Buyer may be an existing Franchisor intending to grow its portfolio or even a large Franchisee that owns multiple units in the Franchise System being purchased.
The Franchisor’s first task when its officers, directors, managers or principals agree they intend to sell the Franchise System is getting the Franchisor ready for market. This includes getting all franchise-related documents in order that a Buyer will request during the due diligence process:
- All versions of the FDDs, including amended versions
- Copies of all state comment letters and effective letters
- Copies of all signed Franchise Agreements
- Copies of Lease Addenda signed between the Franchisor, a Franchisee, and Franchisee’s Landlord
- Copies of correspondence with franchisees, including Notices of Default and Notices of Termination
Note to Franchisors: A potential sale is one of the many reasons why it is vital that you keep Franchisee records for the entire term of a Franchise Agreement
Early in the M&A process, a selling Franchisor will require that the Buyer sign a Non-Disclosure Agreement. Often, a Franchisor will use a virtual data room to store all of the documents the Buyer will request during the due diligence process. These data rooms are password protected, secure, and offer additional protection to the Seller over and above a Non-Disclosure Agreement.
A Buyer’s preparation for purchasing a Franchise System will vary depending on its strategy in purchasing the system, whether it be to simply add to its portfolio or to grow the system through conversion franchises, buying back franchises, or selling more franchises.
During the due diligence process, a Buyer of a Franchise System will speak with management of the Seller, which could illuminate its relationship with franchisees, business ethics, and system culture. It is critical for a Buyer of a Franchise System to have detailed conversations with the selling Franchisor’s management about the FDD process (both the internal disclosure process and relationship with outside franchise counsel with FDD updates), site selection process if the Franchise System has brick and mortar locations, and how the selling Franchisor deals with franchise relationship issues.
A Buyer’s franchise attorney will focus on analyzing the Franchisor’s compliance with franchise law, compliance with franchise contracts, and point out to the Buyer any potential pitfalls in the Franchise System, including franchisee satisfaction, rights of first refusal in favor of franchisees, or other unusual issues. A Buyer’s franchise attorney will typically draft a memo for the Buyer that may be very detailed or may address only critical items, depending on the Buyer’s preferences and budget.
One thing that may surprise a Franchisor is that at some point in the sale process, franchise sales will need to stop. The reasoning is that a sale of the franchise system is a material change, which triggers the obligation to amend the franchisor’s FDD. When in the process this happens depends on several factors, including the risk tolerance of the Seller and Buyer, the Buyer’s goals in purchasing the Franchise System, the likelihood of the deal closing at any point in the process, and how much the type of transaction will actually affect the prospective franchisees and their decision to purchase a franchise. This decision could be especially complicated for Franchisors that count on revenue from franchise sales for operating income.
Regardless of the facts or circumstances of the Franchise System sale or purchase you are contemplating, contact Huck Bouma to speak with a franchise attorney today.