Steps to selling a franchise in 2023
In this section, you can find advice from industry experts to help you prepare your franchise for sale. This includes how to put a value on your franchise and the steps to selling your business. We can help those looking for information on selling a franchise.
Practical advice for selling a franchise
Suki Dehal, Head of Franchising, Lloyds BankThe decision to sell a business is one of the most important choices anyone will ever have to make and for many franchisees it will be uncharted territory. Having invested a considerable amount of time and effort in building the business, its sale probably holds the key to a comfortable and secure future. But many franchisees find that it can be quite stressful and planning for the sale should start well in advance of the time you actually decided to exit the business to help minimise pressure. Consider your exit strategy
Ideally, an exit strategy should be thought about from day one. It is important that there is a clear vision of what you want to achieve and to maximise the value you get from the business it is essential to think about how youâ€™ll leave it further down the line. The franchisor includes terms of exiting the business in the franchise agreement and careful exit planning will help you to maximise the value of the business when you come to sell it if you choose a time when the business is doing well and there are advantageous market conditions.
There are always many factors to take into account in making the decision to sell but unfortunately several of these are likely to be outside your direct control. The primary objective for the majority will be to achieve the highest possible price for your business and you might need to think twice about selling if the economic situation is uncertain. However, it is also important to remember that there will always be a market for any successful business.Plan your exit in advance
The sale of a franchised business can take considerable time to complete and you should start looking for a buyer at least a couple of years before you want to exit and be prepared to leave earlier than you plan if a suitable buyer can be found. Planning your exit well in advance will ensure that you are prepared and it is important that you identify any areas of weakness which the purchaser could use against you during the sale process. The objective is not to make cosmetic changes but actual operational improvement to maximise the value of your business.Consider operational weaknesses
When a buyer carries out their due diligence they are likely to discover any quick fixes that are unsustainable and there is no advantage in presenting an attractive business if it does not have the operating base to sustain the business sales and profits in the future. A common issue that crops up during a business sale is the absence of a formal contract for a key employee, supplier or customer which could have been addressed before the sale process commenced.Factors that influence the value
Several factors influence the value of a business including the timing of the sale however the most important aspect is finding a willing buyer who will actually pay for the business. Obviously if there are several people interested in the business it is likely that you will achieve a higher sale price. The financial position of the business when you decide to sell will be an important factor in the valuation and current, recent and projected profits and cashflow are a consideration as well as how good you are at controlling the business costs. Your businessâ€™ growth potential may also be a factor along with the asset base of the business and how full your debtor book is.How to value a business
There are several methods of valuing a business and the most common is to base the value of a business on a multiple of future earnings. Businesses with a record of sustainable profits are often valued at a multiple of earnings with the profits adjusted for one off items or unusual income. Smaller companies are usually valued at a lower multiple than a similar larger business. Mature cash generating businesses can be valued in a similar way but based on the business cashflow. As asset valuation might be appropriate for stable businesses with significant tangible assets. The franchisor can assist by giving an indication of the sale price of similar franchise territories in the recent past. A potential buyer may use more than one of these methods to obtain a range of valuations however in the end placing a value on a business is a subjective process and will be subject to negotiation.The role of the franchisor
With any franchised business, the franchisor will have the ultimate say on whether the buyer is suitable to become a franchisee in their network and therefore they should be involved in the process at an early stage. You are free to find a suitable buyer yourself however the franchisor is likely to have a list of individuals who want to invest in the business and are waiting for a suitable territory. In many cases the franchisor will charge a fee if they find a buyer themselves. Another way would be to use a business broker to find a suitable purchaser of the business.The role of a broker
A broker will typically charge 10% of the business sale price achieved however will free up the sellers time to concentrate on running the business. Finding a suitable buyer can be very time consuming and using a broker leaves you free to maintain profitability of the business whilst an investor is found. Using a broker will help to maintain confidentiality which is important as knowing that a business is up for sale may upset your customers and staff. Prospective buyers are usually asked to sign a non-disclosure agreement. Once a buyer is seriously interested you will become involved in more detailed negotiations. Once you have identified your preferred buyer it is essential to develop a relationship built upon trust.Consider your target buyer
You could also sell your franchise business to a manager or employee who already has a good understanding of the business and is likely to be attractive to the franchisor because of this. Clearly if the exit planning starts at an early stage you may well have identified someone within the business who has the potential to takeover from you when you decide to sell. Remember selling a business will be easier if you can build a strong client base, show year-on-year profits, maintain premises and assets in good condition and recruit a high quality team around you. Once the initial sale terms are agreed the buyer will review the commercial aspects of the business such as contracts, staff and key customers to ensure that the claims you made about your business are accurate. This process is known as due diligence and will also cover the business past and forecast financial performance and legal and tax compliance issues. A sale agreement is then drawn up which contains the exact details of the sale for all parties to sign which ensures that the final agreement is acceptable and contains no hidden surprises.The role of professional advisors
Maintaining close contact with your professional advisors such as your bank manager, accountant, lawyer, broker, and the franchisor is important throughout the sale process. It is vital that you retain focus during this time to ensure that the business continues to be driven forward despite the distractions of the sale. Selling any business can be a stressful time but careful planning and preparation can assist in achieving a successful sale at a good price.
For further guidance and advice on selling your business please contact Suki Dehal of the Lloyds Banking Franchise Unit
Options for exiting your franchise
It’s sensible for franchisees to plan for exiting the business at a time that suits their personal or commercial goals. However, many franchise owners and operators fail to fully consider the range of options available or engage early enough with their advisors.
So, what are the options for exiting your franchise business? You should start by reviewing your franchising agreement with the franchisor as there may be clauses preventing passing the franchise on or requirements for doing so.
In this article, you will find a high-level summary of the options available when considering the future of your multi-site franchise operation.
Option 1: Pass on to family
The natural choice may be to pass the business on to family, however depending on how this is done, there can be numerous tax consequences and pitfalls. Below we consider the three typical options: Do nothing, gift the business or use a family succession structure.
On your death, as a trading company, the franchise business would likely qualify for 100% Business Property Relief (BPR) if it is mainly a trading business, meaning Inheritance Tax (IHT) would be due, provided you’ve owned the business for at least 2 years. However, there is no IHT if the business is passed to a spouse.
In addition, the recipients would benefit from the Capital Gains Tax (CGT) uplift in base cost. This means that the base cost of their interest would be market value as at the date of death so any capital gains up to that point are not taxed.
Gift the business
For IHT purposes, the gift would be a potentially exempt transfer (PET) so there would be no IHT to consider providing the person making the gift lives a further 7 years. Otherwise, the implications would be the same as doing nothing.
The CGT implications depend on the relationship of the recipient to you:
For your spouse – there would be no CGT with the base cost transferring to your spouse
For a connected person* - the transfer would take place at market value so CGT could apply. However, a joint Gift relief claim can be made between you and the recipient to transfer the gain to the recipient by transferring the base cost to them
Other family – the CGT implications will be the same as a sale to an external party
Family succession structure
There are numerous possible family succession structures such as a trust, investment company, partnership or a hybrid. Each has different tax implications that may also depend on the length of time they exist for. The aim of these options is to manage the transition to the new generation, providing varying levels of control for the founder whilst the next generation can work themselves into the business.
In general, there should not be any IHT unless a trust is set up and exists for more than 10 years, in which case there could be, depending on the circumstances.
Any succession structure should minimise CGT, however corporation tax may need to be considered depending on the structure as will the potential ongoing costs of running the structure.
* A Connected person is defined as: your spouse (though special rules apply), relatives (meaning brother sister, linear descendent or ancestor, but not nieces, nephews, uncles or aunts), the spouses of your relatives, relatives of your spouse, the spouses of your spouse’s relatives.
Option 2: Pass on to staff
Management Buy Out
A typical sale in the form of a Management Buy Out (MBO) would attract CGT in line with a sale to an external party, however it is unlikely that the management/staff will be able to pay the full consideration up front, so it may take several years for the full consideration to be received through the repayment of, for example, Loan Notes which is debt due by the MBO structure to the vendors.
Employee Ownership Trust
An Employee Ownership Trust (EOT) could be set up to purchase the business from you. A key tax benefit is that there is no CGT on sale to an EOT. However, the consideration would not be received straight away. It would be paid from future profits of the franchise business over a number of years.
Option 3: Sale to external party
CGT would be payable on the gain you have made. The prevailing tax rate is currently 20%, however you may qualify for the Business Asset Disposal Relief (BADR), previously referred to as Entrepreneur’s Relief, at a rate of 10%, subject to a lifetime limit of £1m, provided you’ve owned the business for at least 2 years.
The deal structure would need to be considered carefully, as there can several important tax consequences. For example, if an earn-out is included, or in relation to tax warranties and indemnities to consider the risks involved.
About the Author
Aman Nirwal is Senior Key Account Manager of Franchising for BDO LLP. Aman worked for RBS and NatWest for 11 years and then moved into accountancy and professional services. She has worked with owner managed and corporate businesses for nearly 15 years, helping business leaders unlock growth and capital within their businesses.
Aman works directly with business leaders to understand their personal and business aspirations to help drive company strategy in order to achieve the goals of their business. In her role as a trusted business advisor, these types of conversations allows Aman to support your Business with both accounting and non-accounting solutions. Aman has also managed teams of growth advisors and worked across sectors such as tech, media, manufacturing & engineering, motor retail, food & drink and construction.
As a Senior Key Account Manager, Aman is able to assist in creating bespoke packages for Franchise clients, using our ‘Franchise package’ offering. If you would like to find out more on what BDO can offer or you would like to get in touch with Aman, please email firstname.lastname@example.org
Steps to selling your franchise
Once you have decided that you may like to sell your business, the first step is to inform your franchisor. They may be able to source a purchaser for you, though most will charge a commission fee for this.
Any potential purchaser will require a whole range of information about the business before they are in a position to discuss price with you. This information should be provided in a Prospectus of Sale and should include:
- A description of the franchise, what it does and how it works
- Potted history of your business
- The sales history and adjusted profit history
- Details of any property
- Details of any staff
- Details of any equipment
- Copies of 3 years accounts and up to date management accounts
- A realistic asking price
The franchise prospectus
The prospectus is your sales document. Whilst it is designed to sell the business, it must represent an accurate view of what is being offered and must not contain any misleading or false information.
Once a potential purchaser has been found, before providing any confidential information, you should arrange for them to sign a non-disclosure/confidentiality agreement. Once signed you can provide your Prospectus of Sale and other supporting documents and commence negotiations.
At some stage in this process the prospective purchaser must meet the franchisor to be approved as a prospective franchisee. You should agree with your franchisor when they wish to do this. Once agreement in principle on the purchase of your business has been reached between you and your purchaser you should exchange emails confirming the offer for the business and your acceptance of this offer.
A franchise solicitor
Solicitors will usually be needed to complete the legal transfer of the business in question and, though this is not always necessary for small value resales, our advice is always speak to a solicitor before deciding – better to be safe and use a solicitor. It is important however to only use solicitor firms with experience in the resale of franchises and which are bfa members.
Exchange of contracts usually takes place prior to the franchisors training course for the new franchisee and will usually occur the week prior to the course. This however is not set in stone and will vary from franchisor to franchisor. You should confirm this with your franchisor.
The purchaser must usually attend, and pass, the franchisor’s initial training course. If for some reason they are unable to attend training or fail to pass the assessment then the sale may not complete as it is likely your franchisor will not allow them to take on the franchise without training.
Prior to completion of the sale you may be required to instruct your solicitor to give an undertaking for the payment of any outstanding fees, commission charges etc for which undertakings have not previously been given.
All suppliers or providers of leased equipment will need to be notified of the impending transfer in time for the new franchisee to be able to set up credit accounts with them so the business can proceed without pause once completion takes place. Discuss this aspect with your franchisor.
Without the relevant legal undertakings throughout the business transfer process, transfer of ownership may not be authorised by your franchisor. Completion is the day that all relevant funds are transferred and the new franchisee takes over your business. This usually is straight after the training franchisor’s course.
You may well be required to attend the business during the first week or so to introduce the purchaser to your customers and possibly be on call for a few weeks thereafter. The entire process can be stressful as most people only buy and sell a franchise once.
Refusing a franchisee consent to sell
There is a provision in most franchise agreements that outlines if a franchisee wishes to sell their business then they must seek and receive the consent of the franchisor. It does however also stress that the franchisor should not unreasonable withhold giving permission to sell.
What if the franchisor does not like the buyer (the incoming franchisee) or feels that the price it is willing to pay for the business is too high?
Possible financial failure
The point about the price is that if the buyer buys at a price which the franchisor considers to be too high, it may have a very difficult time of making a success of the business.
The margins and the turnover may just not be there to support a purchase price of that nature. It may be a case of the buyer having more money than sense and a franchisor may feel very strongly about granting consent to a sale in circumstances which it believes will lead to financial failure.
In any event, the franchisor is going to have to show that it has reasonable grounds for refusing. Certainly the point about the business being over-priced will be easier to prove than its point about not liking the buyer. The test is going to be an objective one and unless the franchisor can reach some accommodation with its franchisee, a judge will have to decide, something neither of them wants.
Buying with the intent to sell at a profit
Most franchisees buy a franchise with a dream in mind. For some of them that dream is also their ultimate objective, which is that after a number of years of hard work and dedication they will have built up a business, which they will eventually be able to sell. Surveys have shown that around 13 % of franchisees buy a franchise to increase their investment.
Franchisors encourage prospective franchisees in this dream. However, in commerce as in life, things are seldom straightforward. Franchisees who buy on a promise from the franchisor that they will be able to sell often forget that any such promise was coupled with certain conditions. Certainly most franchise agreements are very clear about such conditions.
However, at the time of buying a franchise, franchisees are concerned about other things. They are concerned to secure the franchise and start the business, and having established that, whether they have the right to sell, but do not concern themselves too greatly about the fine detail of the conditions. So what exactly are these conditions? Most are what one would expect:
- Training the buyer
- The payment of the franchisor's costs and (sometimes but not invariably) some sort of fee by way of franchise transfer fee
- Obtaining the consent of the franchisor
- Rights of first refusal in favour of the franchisor (sometimes)
Most seem innocuous enough but the devil, as they say, is in the detail. The condition which creates the most difficulty is the one which requires the franchisee to obtain the franchisor's consent.
Ensuring standards are maintained
Franchisees need to be reminded that one of the prime objectives of a franchisor is to ensure that standards are maintained, and this means ensuring that all franchisees satisfy the franchisor's criteria with regard to ability, skill, financial strength, character, etc.
Just as franchisors are very careful in the selection of their initial franchisee, so they are keen to be equally careful in approving an incoming franchisee who buys from an existing one.
Were they not so careful they would soon find themselves with a sub-standard network of franchisees, many of whom would have acquired their franchise from an existing franchisee. It makes sense therefore that all prospective franchisees, irrespective of how they came to be prospective franchisees (and this includes candidates introduced to franchisors by brokers, consultants etc.) satisfy the franchisor's criteria for franchisees and pass the same rigorous tests.
Those franchisees, while accepting the underlying reasons for the imposition of such a condition, nevertheless feel uncomfortable about the franchisor retaining total discretion as to whom they can sell their business. It is a circle that cannot be fully squared and franchisees usually content themselves with having to rely on the reputation of the franchisor by talking to existing franchisees and doing their homework to see whether or not in the past, the franchisor has exercised such powers as it has retained, reasonably.
Past conduct is of course no guarantee as to future conduct, but it is now by and large accepted practice that most prospective franchisees rely on the reputation of a franchisor amongst its franchisees.
It is not all one-sided in favour of the franchisors. One has to remember that a franchisor has little to gain by being obstructive and in my experience there has been virtually no abuse of such a condition by a franchisor.
As always a distinction has to be made between those franchisors who are ethical and those who are not. Prospective franchisees therefore need to take care to investigate the franchisor's track record and background thoroughly, and to take proper advice on the franchise agreement, because the same set of conditions can have remarkably different effects when operated by different franchisors.
For the buyer the big question is – if it knows that the franchisor is dead against the idea why would it want to persist in its proposed purchase?
© Manzoor G K Ishani. All rights reserved.
Manzoor Ishani is a Senior Consultant Solicitor with Sherrards (Solicitors), a commercial practice advising franchisors and franchisees in the UK and internationally. He has specialised in franchising for more than 30 years and is a former member of the Legal Committee of the British Franchise Association and is co-author of “Franchising in the UK”, “Franchising in Europe” and “Franchising in Canada”, and has helped UK companies franchise into more than 32 countries.
Types of existing franchise sales
If you are looking to purchase a franchise that is part of a well established system, then you will probably be looking at an existing franchise.
There are two types of sale that the existing franchisee can employ; share sale or asset sale. These are both very different and it is important that you and the seller understand the implications of each.
In a share sale, you purchase shares in the trading company. The ownership of the company changes, but the trading business stays exactly as it was before the sale.
In an asset sale, the trading business is transferred from the seller to you. After completion of the sale, the seller will be left with a shell company (subject to any assets or liabilities that the buyer chooses not to take), the other business and assets having been transferred to you. The business is operated by you through a different legal entity.
The asset sale is probably the easiest for all parties concerned as it gives the flexibility to pick and choose which assets and liabilities will transfer; however a share sale is typically more tax efficient for the seller. To put this in perspective, with the right structure a share sale may incur a Capital Gains Tax liability of 18%, reduced to 10% as Entrepreneurs Relief is likely to be available. An asset sale could incur a tax liability of over 50% as Corporation Tax is paid by the company on the sale price and then Capital Gains Tax or Income Tax is paid by the individual extracting the profit from the company.
Share sales pose a greater risk to the buyer as they will inherit all liabilities, known or unknown. This can include tax due, property liabilities and possible litigation by customers or staff. Therefore, buyers will need to gain a thorough understanding of exactly what they are acquiring before committing themselves.
Financial agreements in place
Another area that must be considered is if there are any existing finance agreements in place. With an asset sale there will be a change in legal entity and the lenders consent would be required. This is not the case with a share sale but ‘change of control’ provisions are becoming increasingly common, which allows the agreement to be terminated.
If the franchise operates from premises then there are further issues to consider. If an existing lease is to be assigned to the buyer, the landlord’s consent will be required. This consent is also required for an asset sale and Stamp Duty Land Tax will be payable, another cost which must be factored in.
If the franchisee employs staff, then the type of sale chosen will impact them in different ways. If you want to reduce the number of staff, in an asset sale Transfer of Undertakings Protection of Employment (TUPE) rules will apply but this is not the case in a share sale as the employment contract continues as before.
In summary, there are pro’s and con’s to both the asset and share sale options, with sellers usually preferring a share sale whilst purchasers tend to prefer the simpler and less risky asset purchase.
It is essential that you take legal and accounting advice at the outset and consult with the franchisor throughout the process.
Selling a franchise FAQs
Qu: How critical is it to have defined your exit strategy prior to initially setting up the franchise (for franchisors)?
Answer: As a franchisor the timetable from inception to exit will (or should) be far longer than that of a franchisee. The average lifespan of a franchisee in the UK is around 7 years whereas the same measurement for franchisors is often stated in decades - or certainly a couple of them. That said, essentially the same rules apply to a franchisor or a franchisee - plan and set out your long term strategy from the outset.
The process for franchisor exits is very complicated and the final ease of exit and value obtained will vary depending on the sustainable operating profit generated excluding the profit gained through the sale of franchises. This is important as the value of a franchisor is based on sustainability of fee income not the income generated through recruitment making the point of exit well beyond the breakeven point of the business. Another key point is the consistency of the Franchise Agreements so ensure they are crafted by a fully British Franchise Association ( bfa) accredited solicitor. The final point is to always run the franchise as if it is for sale so ensure it is always attractive to whoever you consider the target purchasers or, as we did with Franchise Resales Limited, grow your own purchasers who will take over through an MBO.
Before launching it is important to obtain the services of a competent bfa accredited consultant who will lead you through the step by step process and will also be able to advise on long term goal planning. The bfa also run a number of seminars for its members covering franchisor exits and the planning for them.
Qu. Is it possible to sell or give back a franchise after a short trading period (6 months) due to family illness? My father is very ill and needs looking after which involves me travelling a lot to be with her. Will the franchisor take it back or let me sell it early?
Answer: There will be a process for this type of incident, your next steps should be to have an open and honest conversation with your franchisor to find an amicable outcome.
The franchisor may take the territory ‘in house’ – or alternatively look to sell the territory to a new franchisee.
Either way, an open and honest conversation with the franchisor is the next step to take.
Qu: I am currently in the process of selling my franchise to one of my staff members and would like to ask two questions please.
As I am currently 1 month over my 5 year contract agreement, so technically out of contract and I haven't resigned a new one, do I have to pay the franchisor’s application for consent to sell fee of £2000?
And as the person buying is currently a staff member and fully trained, do I have to pay the fee for the staff member to be trained by the franchisor?
Answer: The question you put, about the terms of the agreement, is straight forward on one level but less so on another.
The fact your Franchise Agreement has expired does not matter about the terms of it insomuch as the principles of franchising and contract law state that if you continue to operate the business past the expiry date you are deemed to have accepted you will be covered by the terms of the agreement on an on-going basis as long as the franchisor allows this to go on. So, whatever the agreement states still applies.
(On a general point it is always better to re-sign than go out of agreement as this provides you with more security and makes the business more attractive to potential buyers. You still have the right to sell whenever you wish so to do).
The less simple answer is that given your circumstances, and depending on your relationship with your franchisor, they may waive the fee element about franchisors consent – as this is usually applied to cover their costs interviewing and approving candidates on your behalf. Given your buyer is a member of staff, and assuming the franchisor has approved the transaction, there is little for them to do in terms of candidate approval. They do need to approve the buyer even though they are staff so this is an important step in the process.
With regard to training, I believe every new owner should go through the franchisors training programme because it covers the franchisors view of exactly how the business should be run and at this point they can ‘train out’ any non-system habits you may have adopted whilst your ran your franchise. Again depending on your relationship you may be able to persuade the franchisor to provide a truncated or bespoke training process at a leaser cost. Again, this is where cultivating a good relationship with the franchisor pays dividends.
Looking at it from the franchisor point of view, they want to ensure that whoever takes over from you will do better than you have and will continue to grow the business in the future so that is the angle to use when speaking with them.
Qu: I have a cleaning franchise which I want to sell as I am wishing to retire. The franchisor in my opinion, and that of others wishing to sell, is that it is not being helpful with the resale. The advert for resales is placed on one website which is not well known and is very hard to find if you are searching on the internet. The problem is this is a franchise with an allegedly good reputation and a member of the BFA. In other words, it looks like a closed shop - this is not good. It is quite obvious to me and others that they do not care about the franchisees who have worked hard and made them money over the years and have no interest whatsoever in getting them a good price for their business. How would you suggest to proceed with putting your case forward to this company that it is in everyone’s interest to be more helpful in selling the business for the franchisee?
Answer: The question you raise is not unfamiliar to me as many franchisors main focus is growing their network though new franchisee sales rather than focusing much support on those planning to exit. That said I fully understand your frustration when there isn’t much effort being demonstrated by the franchisor.
The whole relationship with your franchisor is defined by your franchise agreement (FA) – to a certain extend that is the only document that matters – so within your FA there should be a series of clauses (usually around clauses 15 to 20 somewhere) which sets out the franchisors obligation with regards to your resale. It is likely to be restricted to having to approve the prospective purchaser unless they find the prospect for you in which case they will most likely charge you a fee. There should be no restriction upon you seeking your own prospective purchasers though the franchisor may still impose a handling fee of some level – usually a percentage of the selling price. Given you state your franchisor is a bfa member their FA should follow this approach
As regards addressing the position with the franchisor I would suggest an open and non-confrontational discussion about how you can plan for your exit and retirement given your wish to do so. They should let you know you are able to find your own prospects for a sale and instruct an external firm to work with you on this, always remembering the franchisor has to approve the candidate, then you are free to follow that line of action.
Qu: I purchased my franchise and started it in May of this year. It did not start brilliantly and has not got any better. I have asked the franchisor for help as what they promised with the system provided has not worked leaving me basically earning no revenue.I have now decided to call it a day but they are telling me that I have to continue if I want to sell the business on or if I walk away it reverts back to them to sell and make more money. I explained to them that I could not afford to do this as it is costing me too much money. I do not think the support and training provided has lived up to the standard that they advertised.
Could you advise me if I have any grounds for a settlement from them also I spoke to someone who provides the system that was put in place for me and they said it is not really sufficient for what we are using it for.
Answer: I sympathise with your situation as it seems the franchisor is not being overly supportive of your position. This is definitely a situation which requires a legal opinion as it is not possible to advise a course of action without having a copy of the franchise agreement for your particular franchise and all the correspondence to hand. Logically you will have four options; find a purchaser for your business yourself, get the franchisor to find a purchaser for you, cease to trade or work with the franchisor to trade out of the position and continue.
Your first port of call needs to be a franchise specialist solicitor (please don’t just use a local lawyer). I don’t think you should make any decisions without this specialist advice.
It will be important to retain a working relationship with the franchisor regardless of whatever route you decide to take.
Qu: I have a franchisee who wishes to sell their business. They have approximately 18 months left on the term. They have an interested party. If they choose to buy the new franchise do they sign a new five year agreement? Am I entitled to any of the money from the franchise sale?
Answer: The best advice for franchisors when selling an existing business is to terminate the old agreement and start afresh with a new agreement with a new franchisee. Your solicitor will be able to draft a simple termination letter for the outgoing franchisee.
This process means you are constantly updating your franchise agreements and extending the general term of the franchise as each one that sells will in effect be a new agreement so all will eventually roll on.
There should also be a sale and purchase agreement between the seller and buyer.
As with regards fees your franchise lawyer that drafted the original agreements will have discussed a resales clause with you and the sums you can or cannot charge will be in the current agreement under the resales clause.
Qu: What is the best way to value a franchise resale?
Answer: Most resales are valued by their ability to generate sustainable operating profit. That is the amount of money somebody buying the business could reasonable be able to generate if they ran the business in the away it is currently. This operating profit does not include any owner’s drawings, pension provision or other costs of a personal nature to the owner. It also would not usually include interest payments or any tax payable.
Most accountants would average this out for the last three years with a weighting towards the latest results. They would then apply a multiple to that average figure to arrive at an asking price. Typically, for small businesses, multiples these days range from 1.5 times to 3.5 times depending on the industry sector.
Qu: I run a Domestic Cleaning franchise with an annual turnover in the region of £55K with outgoings less than £10K. I am considering selling in the next few years and would like an estimate of the resale price of my business.
Answer: Most resales are valued by their ability to generate sustainable operating profit. That is the amount of money somebody buying the business could reasonable be able to generate if they ran the business in the away it is currently. This operating profit does not include any owner’s drawings, pension provision or other costs of a personal nature to the owner. It also would not usually include interest payments or any tax payable.
Most accountants would average this out for the last three years with a weighting towards the latest results. They would then apply a multiple to that average figure to arrive at an asking price. Typically, for small businesses, multiples these days range form 1.5 times to 3.5 times depending on the industry sector.
In the cleaning sector the level of multiple will depend on whether the enquiries/contracts are provided by the franchisor or if you have established your own customer base.
Given the basic information you provided you indicate this operating profit level to be around £45K. If this is consistent over the years and is not totally reliant on you as an individual then you may be able to achieve a reasonable multiple. Clearly this is a very rough view as I am not aware of the brand, what it costs to set up a new franchise, how it operates or the business structure you operate. All of this would be needed to be able to provide an accurate calculation.
Qu: I am nearing the end of my franchise agreement (5 months) and I am looking to sell the business and do something different. I would like to sell the 'Asset Value'.
My question is how do I value the franchise re-sale? I have been to a number of business transfer agents and they say that I can only value the resale based upon net profits and not on a multiple of net profit plus initial franchise fee. Is this correct? If this is correct then a potential new franchisee could purchase a franchise resale for less than a new one with no revenue stream, which does not make any sense! I am missing something here? I have been making a technical loss of £10K after drawings/expenses etc?
Answer: The advice you have been given is totally correct. The value of a resale, whether franchised or not, is based on that businesses ability to generate transferable operating profit (profit before drawings, tax etc). You are not able to add on the franchise joining fee when you launched the business because that was for the franchisor to grant you the licence, train you and support you during the initial trading period and has no bearing on the ongoing profitability of the business.
The reason this is not done is that a business is expected to generate profits from its effective operation and driving by the owner. A purchaser will look at this profit and take a view on how much they will pay for that business based on what they see. They usually apply a multiple to the average profit for the past few years and make a judgement based on that calculation. Some franchisors will re-charge the joining fee to your purchaser anyway, though many franchisors do not do this.
You are correct that a franchise which has been run at a loss it may well sell for less than the original fee paid to set it up. This would be an unusual situation but may, from what you write, be the situation in your case. In these circumstances I suggest a dialogue with your franchisor to see if there is a mutually agreeable approach for them to help you to exit their franchise.
Qu: What fees should i expect to pay the franchisor or a broker, if I want to sell my franchise?
Answer: Many thanks for your question about fees chargeable by brokers and franchisors when selling existing franchisees businesses.
The easy answer is that franchisors can charge whatever they put into the Franchise Agreement which a franchisee has signed (this is why one should always consult a bfa accredited solicitor before signing). They may be willing to discount any fees but may not charge more than that stated.
The more complex answer is as follows:
Typically, a franchisor will have two types of fee applicable to a resale of a franchises business.
1. The Transfer Fee: This fee is payable to compensate the franchisor for the time and trouble they take to allow one franchisee to go and to take another one on. Sometimes this is a lump sum of money such as £2,500 - £5,000 or so, and sometimes it is a percentage of the selling price, typically 5% these days.
2. Commission Fee: This fee is payable in addition to the transfer fee if the franchisor sources the purchaser. Typically, this would be an additional 5% making the cost to the selling franchisee 10% overall.
I have come across combined transfer and commission fees of up to 25% but these would be rare in franchised operations that are members of the British Franchise Association. The bfa have some pretty strict rules about ethical franchising and very high fee structures do push these boundaries.
If you use an external business transfer agent/business broker they will be acting for you, so you would be deemed to have found your own purchaser, and therefore only the franchisors transfer fee would be applicable. Brokers typically charge between 5% and 10% of the selling price as a fee and many will charge an upfront commitment fee though this is often discounted from the final fee charged. Most will have a minimum fee payable in any transaction.
As a selling franchisee you should therefore expect to pay around 10% in terms of fees plus some legal fees depending on the complexity and structure of the sale.
Qu: When buying an existing franchised territory from an established franchisee, is it common practice to pay in full upon signing? The franchisor provides training and is expecting its own franchise agreement to be signed at the same time, but as it is stakeholder and reserves the right not to let the purchaser operate the franchised territory if deemed unsuitable, so I consider paying the purchase price in full long before completion, and actual business handover, to be unethical. What is normal practice in these situations when the franchisor is not selling the whole package yet still has an interest?
Answer: The usual practice is that the seller receives the full payment, less any agreed deductions, upon completion of the sale. This usually takes place after training has been completed and the new franchisee has “passed” the training course. Most franchisors will reserve the right to disallow a sale to complete if the candidate fails to perform on the course.
Also, it is good practice for franchisors to insist on the Franchise Agreement being signed prior to training as this protects their processes and knowhow and quite often they ask for their franchise fee or training fee to be paid at this time. It is however hardly heard of that the full transaction value of a resale would be paid prior to training – the seller may ask for a deposit at this stage to show good faith.
The usual process is that a Sale & Purchase Agreement (SPA) has been drawn up by your solicitor, passed to the seller’s solicitor for agreement and then finally agreed between the parties. Often (and I always did this when I was a franchisor) the franchisor will wish to be a party to the agreement and either OK or alter the terms agreed. The SPA goes though an exchange process (just like a house sale) the purchaser goes on training at that point and the sale completes post training when the money is paid (again just like a house sale).
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