As the number of franchised stores continues to grow, the opportunities to purchase an existing franchise are increasing exponentially. However, purchasing an existing franchise brings with it additional concerns that do not typically exist for franchisees who are opening a brand new outlet. There are many considerations that potential franchisee must be aware of when deciding how to enter a franchise system.
Lease Negotiation – The current trend for new franchisees is to sign their franchise agreements without having a location picked out. As a result, new franchisees can pick a location and negotiate lease terms with which they are comfortable. If they do not like a particular location, landlord, or arrangement, they can move on to other locations. Franchisees purchasing existing stores typically do not have the same negotiating opportunities, and in many cases are forced to assume a lease with the same or similar terms as the old lease.
Lease Term – Franchisees who open new franchises typically understand that their franchise agreements terms (i.e. length) should match the lease term. If the terms do not match exactly, franchisees should make sure to secure lease options, renewal rights, etc. For franchisees purchasing existing stores, the coordination of franchise agreement and lease terms is more likely to be overlooked by the franchise purchaser. These franchisees often think that since the store has been operating already, the landlord will agree to allow the store in perpetuity. This is not the case, and franchisees purchasing existing stores must be wary of this. Also, many incoming franchisees simply “assume” the obligations under the old lease. If this happens, the incoming franchisee must be sure to modify the term of the lease to assure that it coincides with the franchise agreement. Otherwise, they could end up with a franchise, but no location.
Consents – Buying an existing franchise also requires various consents prior to the purchase. Franchisees purchasing an existing store typically must contain the landlord’s consent to assign the old lease or consent to terminate their old lease. Without the landlord’s consent, a new franchisee cannot typically take over. In addition to the landlord’s consent, the transfer of an existing store also requires the consent of the franchisor. Contrary to popular belief, franchisees cannot sell their stores in the same manner as non-franchised owners. Franchisors always want input as to who will be operating under their brand. To the extent there are loans secured by the existing franchisee assets, the bank may also need to get involved. Franchisees purchasing existing businesses need to obtain and coordinate these consents so that the transaction moves forward quickly and effectively.
Franchise Agreements – Unlike new franchisees, existing franchisees typically have franchise agreements that are ongoing. An incoming franchise purchaser must be aware of whether the franchisor will require the assignment of the old franchise agreement, or require the franchisee to enter into a completely new agreement. Most franchisors require the latter. However, if the franchisor requires the assignment, an incoming franchisee could find himself with only a limited time left on the agreement. Because most franchise agreements do not require automatic renewal, and require franchisor approval, a franchisee could find himself without a franchise in a relatively short period of time after purchasing the existing store.
Financing – By purchasing an existing franchise, a franchisee may also add another party to the mix when it comes to financing. When a new franchisee enters the system, loans are typically bank or other third-party loans. Most franchisors do not lend money to assist franchisees with their cash flow (although some will extend limited financing for the purpose of paying back the initial franchise fee). Franchisees who purchase ongoing concerns may end up entering into a promissory note with the seller to pay the purchase price over time. In these instances, an additional complication is injected into the mix. Many franchisees do not realize that their franchisors require input as to these arrangements, the purchase price of the business, etc. Some franchisors will not approve a franchise sale where a franchisee’s debt to the prior owner is too high, because they believe the franchisee will have cash flow issues.
The above areas are not exclusive and there are many other differences between the purchase of a new franchise, and the purchase of an existing franchise. These difference must be considered in advance, to avoid last minute delays and problems that could be avoided early in the process.
Brian is a commercial litigator with more than seventeen years of experience representing clients in the franchise industry. Brian routinely assists clients during the licensing and franchise/FDD review process, as well as with the resolution of franchise-related disputes, including those involving terminations, territorial disputes, fraud, disclosure/relationship law violations and breaches of contract.
In addition, Brian represents and counsels clients in the construction industry on matters involving litigation, construction defects, licensing and compliance, collections, mechanic’s liens, payment bond and Miller Act claims, contract drafting, and compliance with home improvement laws and other construction industry laws.
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