Decisions, Decisions

Be careful how you make your decision about what to do when your term is ending. In addition to likely being required to pay a renewal fee, your franchisor will generally want you to bring your business up to its current standards. That might require you to make a substantial additional investment. Don’t assume you will recoup your entire investment if you upgrade the franchise. Work with your accountant and other advisors in making this type of decision.

Sometimes the decision to leave may not be yours. Although you may believe you have the right to enter into a new or continuing franchise agreement, that may not necessarily be true. Your franchisor will, in most situations, also have some choices to make if you have not been a solid franchisee during your existing term, have not been paying your royalties, or have been violating other aspects of your franchise agreement. If that is the case, your franchisor may not want to extend the relationship with you. In some situations, you may not even have any successor rights, and the choice to continue — of course, subject to the law — may totally be in the franchisor’s hands. However, in a few states there are laws that limit a franchisor’s right to not renew your franchise. Working with a qualified franchise lawyer or consultant is essential in advising you on the impact of these laws.

But in most situations, you may be choosing to leave the franchise system because you want to and not because you have to. Your reasons will vary. If your franchisor’s brand is wildly popular, or your business is wildly successful, selling out while the value of your business is high may offer you a great opportunity.

Or the reasons may be more mundane. Perhaps your spouse or significant other has received a great job offer out of state. Maybe you simply miss your grandkids who live in another state, and selling your business so that you can live closer to your family is the right life choice for you.

Perhaps, even when the business is financially successful, you are simply just tired of it. You have rolled one too many bagels, heard one too many complaints from customers, or butted heads with the franchisor one too many times — and it is just time to do something else. Whatever your reason, ending the franchise relationship does not have to be as ominous as it sounds. It could be a new start for you.

When you signed your franchise agreement, you most likely did not obtain the right to run your franchise indefinitely. Under the franchise agreement, a franchisee obtains the right to use a franchisor’s brand and system for a specific period of time. Depending on the terms of the franchise agreement, the franchisee’s rights to operate under the brand and system may last 5, 10, 15, or even 20 years. The clock usually starts ticking on the day the franchise agreement is signed, but, depending on the franchisor, might begin when the location opens for business. If the latter is the case, your franchisor gave you additional time to amortize your investment by not counting the time you spent in finding and developing your business prior to its opening. It is not usual, but it can be a great benefit to you as the franchisee at the time.

At the end of the term, you have some choices to make:

You can leave. If you don’t want to continue running the franchise, you can simply thank the franchisor for the opportunity and move on. You will be giving up the right to operate a business under the franchisor’s brand, and the franchisor may resell the rights in the market to a new franchisee. You likely will be able to sell the building (if you own it) or any equipment or other assets so long as they are not proprietary to the franchise system. The franchisor may also elect to exercise an option (if granted to the franchisor under the franchise agreement) to assume the leases for the premises and equipment. Or purchase all or certain of the assets of the franchisee’s business at a predetermined valuation or based on an appraised fair market value.
You can sell. You may choose to sell the business to another person. But remember, your buyer will need to first be approved by the franchisor to operate the franchised business. In addition, the franchisor may require the new franchisee to sign a new franchise agreement, and in some situations, the franchisor may have some say over the amount the new franchisee pays you for your business.

Generally it is to your advantage if the franchisor is willing to grant your buyer a new franchise agreement, because you may have only a few years left on your franchise agreement and a new franchisee will likely pay more for your business if they have a longer period in which to operate it.

On occasion, a franchisor may have a say over the price you set for your business’s assets. If the price paid by the new franchisee concerns the franchisor because it reasonably believes the new franchisee won’t be successful given the amount of debt they will need to service, the franchisor may disallow the sale at that price. If that is the case, your options may include reducing your selling price. In some instances, the franchisor may be satisfied if your buyer simply puts up more cash and reduces the amount of loan they will be carrying.
You can switch. In some cases you may want to end the franchise relationship, but if you like the business, you may desire to continue to operate a similar business not identified by the franchisor’s brand or system. You might even be considering joining a competing franchise and becoming identified by another franchisor’s brand.

Unfortunately, in the majority of cases, this is not a viable option because typically you will be bound by a non-compete provision prohibiting you from operating the same or substantially similar business at your current location or near any other locations within the franchisor’s system. Moreover, the duration of the non-compete provision generally extends a few years beyond the expiration of the franchise agreement. As noted earlier, the franchisor may elect to exercise its option under the franchise agreement to assume the lease for the premises and/or purchase the assets of the business, subject to the laws in your state.
You can continue. If you want to continue to operate your franchise for another term, expect some changes. In most cases, in order for you to obtain a successor franchise, you are required to notify the franchisor in writing of your desire to continue (generally the notification period is six months or longer). You will also be required to make an additional investment to bring your business up to the franchisor’s current system standard for new franchisees, and you will be required to sign a new franchise agreement. The terms of that new agreement will likely be different from the terms contained in your existing agreement.

As always, make certain you review the new franchise agreement with a qualified franchise lawyer before you sign on the dotted line.

Going for Round Two (or Three or Four): The Successor Franchise

This section covers the last of the options mentioned in the preceding section: obtaining a successor franchise.

Paying the successor fee (if there is one)

Some things don’t change. Just like when you first made the decision to sign your franchise agreement, you have the same kinds of decisions to make again.

Every franchisor varies its approach to granting successor franchises. Many franchisors will grant you a franchise for the same number of years as your original franchise agreement, such as a ten-year original term with one ten-year successor term; others may be for a shorter period of time. How long and how many additional successor terms you have available to you is likely specified in your original franchise agreement. Check out the specific terms of the franchise agreement — don’t assume that the brand is available for you to use for life.

Some franchisors don’t charge any successor fee, but most do, and that fee may vary from franchisor to franchisor. Successor fees may be a flat amount ranging from several hundred to several thousand dollars. They could also be a percentage of the then-current franchise fee, and on occasion may even be the same fee charged to new franchisees.

Many franchisee advocates argue that there should be no successor fee because the franchisee isn’t starting from scratch. The argument is that they have mastered operating the franchise, require no initial training, site selection, or inventory advice because they completed those steps a long time ago. In our opinion, charging a successor fee is fair. There is a commercial value to your continuing to use the franchisor’s marks, and system and the successor fee reflects that the franchisor’s intellectual property has value. Although they won’t usually be much, the franchisor will also have costs.

The successor franchise agreement

Typically, the terms of the successor franchise agreement will be different than those of your original franchise agreement. After all, a number of years have passed since the original franchise agreement was signed and the franchise system and market have evolved and changed. In addition, the value the franchisor assigns to its system likely has increased with experience and over time. Finally, changes in the law and the standards and practices in franchising may also mandate revisions to the franchise offering.

To avoid being blindsided by the changes, you should keep yourself informed about the franchisor’s current franchise offering throughout your term. Because your existing agreement might — in rare instances — include provisions that limit the franchisor’s rights to make certain changes, you need to seek the help from a qualified franchise lawyer before signing your successor agreement. Where capital will be required for things like modernization, you will also need to be financially prepared. So, understanding the costs involved in opening a new location will give you a gauge of what to expect should you need to remodel your current location.

Here are some of the more common changes you can expect to see between your current franchise agreement and the successor agreement offered:

Royalty and advertising fees
Territorial rights and restrictions
Alternative product and service distribution approaches adopted by the system
Remodeling or modernization requirements
New technology such as a point of purchase (POS) system, equipment, menu boards and signage
Training requirements
Supply chain and required purchasing arrangements
A change of focus to multi-unit developers
Other material changes to the business terms of the relationship

Whether or not the franchisor requires you to modernize your location at the expiration of your franchise, by the time you sign your successor agreement, it likely a good idea anyway to modernize your business to meet the system’s current brand standards in order to stay competitive.

You may want to remain in the system, but you have the option of leaving. In most situations, the franchisor wants to retain you since finding and opening a new franchisee for your market can be expensive and disruptive. Understand that you may have some bargaining power available to you if the franchisor appears to be requiring excessive remodeling or updating. Some franchise agreements may also include a dollar cap on remodeling costs.

Before you sign your successor agreement, most franchisors typically will ask you for additional items including evidence that you can continue to occupy your business location during the new terms and that your insurance coverage meets the system’s minimum standards. In addition, the franchisor will likely require you to sign a general release of liability of all claims under the prior franchise relationship in their favor. The purpose of the general release is to provide the franchisor with assurance that any claim you may have or might be able to assert against them is gone before you execute the new franchise agreement. If you are agreeable to signing the general release as a condition of obtaining a successor agreement, you can ask the franchisor to make the general release mutual. In most situations you should not expect them to agree to do that, but you have some bargaining chips to play, so it doesn’t hurt to ask.

Changes that have sparked controversy

Though no one likes changes in an agreement just to continue a relationship that has worked for the past ten or more years, most of the changes the franchisor is requiring are necessary business decisions and less than controversial. But some can spark a heated debate between franchisor and franchisee advocates.

Dispute resolution

Dispute resolution has long been an issue because it involves the method used to resolve disputes, the state where disputes will be resolved, and even what types of methods will be used for different types of disputes.

Attorneys of all persuasions will vary on the benefits of submitting all claims to arbitration or to a court or a jury. Franchisors like the “home field advantage” and the practicality of their headquarters state being the agreed-upon venue. Franchisees would similarly prefer any dispute to be handled in their home state. Further complicating matters, some state laws require the franchisor to bring any lawsuit in the franchisee’s home state. Some franchise agreements also incorporate a requirement for mediation as a pre-condition to any arbitration or litigation proceeding.

Consulting with a qualified franchise attorney will be important in order for you to understand the ramifications of these provisions. This is especially true because most franchisors won’t negotiate dispute resolution provisions.

You won’t find it in many franchise agreements, but several franchisors have adopted an ombudsman approach. An ombudsman exists within a franchise system to help facilitate the resolution of disputes before they escalate into full-on litigation or arbitration. These programs can be effective if they are set up and managed properly. Even if your franchisor doesn’t have an ombudsman, you might request that it agree to using a third-party program like the one set up by the International Franchise Association (see http://franchise.org/self-regulation-ombudsman).

Supply chain rebates

As part of their mix of continuing revenue, rather than rely simply on the continuing royalty, many franchisors earn income through the system’s supply chain. Where the franchisor is selling directly to the franchisee, as you will find with any other supplier, the wholesale price they set will include a markup to cover their costs and make a profit. The amount of the wholesale price is frequently an issue because the franchisor may be the sole supplier, and it sets the prices to be charged to the franchisee.

Many franchisors also receive rebates or commissions from suppliers based on the purchases made from that supplier by the franchisees. The right to receive rebates, commissions, and discounts from suppliers will be disclosed in the franchisor’s FDD in Item 8, and the franchisee may be required to purchase only from suppliers authorized by the franchisor. As with the markup on products and services sold directly, the rebates received from the suppliers will usually be revenue to the franchisor, although in some systems the rebates may be shared with the franchisees or contributed to the system brand fund. How the franchisor is earning revenue off of the supply chain may have changed from when you signed your initial franchise agreement, and that change could impact your cost of goods.

Territorial rights

Ten years ago, when the franchise system was newer, the franchisor may have provided you with an exclusive market area around your business. This might have been because the franchisor didn’t know the size of the territory needed by the franchisee, or because the franchisor believed that in order to recruit franchisees, it had to provide an exclusive territory. Times have changed.

Consider the difference between a nonfranchisor, like Starbucks, that places its locations most convenient to its customers, and a franchise system restricted to where it can put locations because of territorial restrictions provided in franchise agreements. Franchisees prefer territorial protection, but the franchisor is seeking critical mass and exclusive territories that were set years before hamper that capability. That’s why your exclusive territory may have vanished in total or the franchisor may have instead converted it to a protected territory in your new agreement. Even where territorial rights of some form are still provided, the size of that territory may have changed.

Alternative distribution

Nontraditional locations include venues like airports, university campuses, hospitals, sports arenas, convenience stores, and other locations where consumers may purchase your product or service but you were not the reason they went there in the first place. We call those mass-gathering locations. Also franchisors, like most businesses, have discovered the power of the Internet to sell their products and services — and the Internet is not local, but global. E-commerce may not even have existed when you signed your last franchise agreement. More than likely, even if you still have some territorial rights, you will find carve-outs removing mass gathering and the Internet from your territorial rights.

If the franchisor obtains significant revenue from e-commerce, and the online sale of products and services are significantly affecting your walk-up business, you may want to discuss receiving some benefits from the franchisor’s e-commerce business — either in the form of referrals, access to national account business, marketing assistance, or a portion of the sales made to customers in your market. Be sure to ask, but understand that your franchise was likely limited to the business derived from your location, and Internet sales, though they may impact your business, are made outside of where your business is located.

Where the Internet may have an impact on your sales, talk to the franchisor about developing additional training and support of a retail theater approach to your brick and mortar location. Retail theater is a relatively new but effective approach that companies use to integrate Internet sales within their brick-and-mortar locations. No matter how impactful the Internet has become, there is nothing as powerful as a great human salesperson when coupled with the technology of the Internet and the knowledge of how to use it effectively in their business. Michael Seid, your friendly co-author, works with MSA’s retail and manufacturing clients in developing and executing the retail theater approach.

RETAIL THEATER

When executed properly, retailing is no more than theater designed to engage consumers and deliver successfully on a retailer’s brand promise. Consumers are overwhelmed with choice today, and although price and convenience have become the simple hallmarks of the electronic merchant, it is the ability of the brick-and-mortar merchant to make a connection and engage with the shopper in real time that is their most effective and competitive tool. Creating an environment that attracts customers into your store is essential, but what is most important is to keep them wanting to return as buyers. Retail theatrics — delivering the retail experience with the unique excitement that only a live presentation allows for — provides the buyer with an informative and differentiated experience in which the entire cast, the merchant and the consumer, are part of a very scripted but impromptu interactive retailing play.

Customers don't seem to be following the old retail rules any longer. The rule has always been that if you put a store in a high-traffic area, with good visibility, great signage, and a few strong anchors drawing a similar customer profile, customers will come. Provide them with friendly customer service, and they will buy. Retailing was a lot easier before the Internet. Amazon has become the everything store, and it is expected that soon it will carry more than 80 percent of what we buy — at better pricing and with better delivery than most brick-and-mortar stores can muster. The Internet has opened up the world of non-geographic retail — a retail world without a need to visit physical stores. Your challenge as a brick-and-mortar retailers is to make visiting your location a compelling necessity instead of enabling your customer to buy at another retailer or e-tailer.

Have you visited an Apple store recently? The greeter not only can confirm appointments and wait times at the Genius Bar but can also directly communicate with staff and call them forward to meet with you to discuss what you’re shopping for. You can purchase most Apple products at Best Buy or online, but why would you? There’s an excitement about the interactive experience at Apple. In addition to associates with extraordinarily deep product knowledge, there are tables full of products you can try out, and like a Disney Store, there’s an area with iPads that children can play with while you shop. You can research products online and schedule to pick them up at the local store. You can book time online at the Genius Bar and get updates on the time of your appointment. And rather than simply sell the customer a MacBook Pro or iPhone or iPod and have you wait on line at a cash desk, they bring the cash desk to you in a handheld credit card reader. Want a printed receipt? No problem. Rather have it emailed to you? That’s Apple’s preference anyway because they can capture your contact information and keep you informed later about new products and features. Having the sales associate bring the cash desk to the customer is becoming more and more common with theater retailers, and even brands like Hertz are doing it today. Learning about becoming a retail theater instead of just a location allows bricks-and-mortar locations to remain competitive in an e-tail economy.

Bowing Out at the Right Time

The franchisee opens the store at 10 a.m. sharp, hires more employees to service the evening customers who pick up their vitamins or get their hair cut after work, and insists that their employees greet the customer within 20 seconds of entering the door. The franchisee does these things for a reason: timing. Running the franchise according to the clock makes sense. The same goes for selling it: There are right times and wrong times to exit. The timing depends on inner and outer forces, including your personal situation, professional aspirations, the franchisor, and market changes.

There’s nothing wrong if you decide to exit your franchise, but keep in mind that the buyer of your business is going to want to know why. The reasons you give can impact your selling price because if the prospective buyer senses urgency, they may try to get you to lower your price. If a prospective buyer understands that the franchise system and your industry are flying high, the buyer may pay a premium for the privilege of entering the franchise system.

If the franchisor is granting your buyer a franchise agreement with a full term, that may be a significant advantage to you in selling your business. Talk to the franchisor in advance of putting your business up for sale so you can position your business appropriately.

Getting personal

If stress or, ultimately, burnout is having a significant negative impact on you, what can you do to rejuvenate yourself? Maybe taking a long vacation to recharge is what you need. When was the last time you spent some time alone with the family? Are changes needed in your personnel or the culture at your location?

A bad reputation will spread faster than a good one. If you’re burned out or have outgrown the business, it makes sense for you to exit before the business and, subsequently, the resale price begin to suffer.

On the other hand, maybe the economics of your business is changing or you see a new opportunity or want to relocate or retire. Here, financial factors are likely more critical, and you need to get the most when you sell. Maybe you anticipated retiring in five years, but an unsolicited and incredible purchase proposal presents itself. That may also be reason enough for you to sell now.

Examining your world

Begin by assessing the economy and the trends for your business. Good economic times and having positive market trends are conducive to selling at a higher price. When interest rates are low and financing is plentiful, more prospective buyers come forward. Can you afford not to take the right offer? Maybe with the proceeds from the sale of your existing business, you can relocate to a long-desired location and invest in a new franchise. Or maybe you can take the proceeds and invest in development rights for multiple units from your existing franchisor.

Assessing the local market is also critical. Are new businesses coming in to your area? Is the area undergoing revitalization? Is the landlord making improvements to attract new tenants and customers? If the answer to these questions is yes, that could bolster the price of your business. In contrast, if the surrounding neighborhood is starting to look shabby and the landlord is leasing to less desirable businesses, you may have missed your best opportunity to exit at a higher valuation.

Then you need to look at the industry itself. A thriving industry could mean a lucrative sale price. A franchisee may want to cash out before the market is saturated, a fad fades, or new technologies make the business obsolete. Even with a retail theater approach, consider how technology has impacted the way customers shop and what they are shopping for.

What is the state of your franchise system? Although you conducted your due diligence on your franchisor when you first came on board, things may have changed — for the better or for the worse. If same-store sales are starting to get soft because new and innovative competitors are entering the market, maybe the time is ripe for you to exit. If instead you believe the franchise system is and will continue to be a leading market competitor, you may want to keep operating and even expand development plans to include more units.

Some red flags that worry prospective buyers include the following:

Franchisee lawsuits
Negative press
Uncontrolled system growth or unprecedented franchise closures
Sagging system-wide sales
Unacceptable changes to new franchise agreements
Management shake-ups
Some other company acquiring the franchisor

Leaving It to Your Children

Little Johnny has swept the floors at your store since the broom was taller than he was. Little Jane has stuffed marketing coupons into envelopes since before she could write a complete sentence. Sound familiar? It should. Your co-author Michael Seid began to work in his family’s business packing shelves and learning the trade before starting first grade and the family store was like his second home. His experience is not at all unusual.

Have you given any thought to your children not just as helping hands but as potential successors to your business? Growing numbers of franchisees have that very mindset and take steps to create estate plans based on a franchise relationship that will be passed down to a franchisee’s children and heirs.

Children who have worked hard, love the business, and have helped build value may be ideal successors to your business and may be attractive as franchisees to your franchisor. Like any parent, many franchisees probably think that their kids can do anything. But keep in mind that because your business is part of a franchise system, your franchisor will need to feel the same way about your kids if your children are to assume your role.

Franchisors normally reserve the right to approve a transfer of ownership — even to family members. If an owner dies or becomes permanently disabled, some franchisors allow assignment of the franchise to a spouse or heirs without prior approval. More typically, franchisors require approval of the proposed successor franchisee within a certain time period, usually within 6–12 months. Some franchisors waive the transfer fee for these transfers.

Next-generation approval criteria are generally not described in the FDD or franchise agreement, so you should inquire in advance about the franchisor’s requirements to approve a transfer upon your death or disability.

Gradually acclimating a son or daughter to the franchisor may also help. Take the child, at an appropriate age, to franchise conventions and training, for example. Many franchisors have developed “next gen” programs for the children of franchisees. Talk to your franchisor about its next gen program. If you’re thinking of transferring your business to the kids, it likely is a good idea to enter them into the program early.

Smoothly passing a family business upon your retirement or death requires planning. Don’t assume that the franchise will be part of your estate. You need to discuss this with your franchisor and examine it with a qualified franchise lawyer and accountant. Know your rights. Ask a few questions:

What are your rights to transfer the business?
Are your children and spouse acceptable to the franchisor?
What are the criteria for the franchisor to approve the transfer, and can you get approval in advance?
Does the franchisor have a next gen program?
How much time remains in the initial and renewal terms of the franchise agreement?
What form of agreement will you be able to transfer — a full new agreement or something less? If it’s a new agreement, what are the changes from your current agreement?
What renewal options are available? Who has to execute them to get the most benefit?
Does the franchisor have a right of first refusal to buy the business if you try to transfer it, and will the franchisor waive those rights in advance?

It bears repeating that transferring a family business has serious financial, legal, and tax consequences. Before handing over the reins, you will need to develop an estate plan, which includes the current fair-market value of the business, and a succession plan.

Consult with accountants, estate attorneys, investment advisors, insurance agents, and family business consultants. The franchisor may offer succession-planning advice. Nationwide, about 100 family business centers affiliated with universities provide education on family business topics. For programs near you, ask your lawyer or contact the IFA’s Franchise Education and Research Foundation at www.franchise.org/educational-foundation.

Letting go of control of your business is often difficult for many to accept. Upon succession, your children will likely still have to go through training and learn from their own mistakes.

Selling Out

If you want to stop operating your franchise, you should consider how you will benefit from all of the sweat equity — and real equity — you have pumped into your business. Value is there, and you should reap it. Every franchisee has the right to maximize the value of their business during its term based on the terms contained in the franchise agreement.

Smart franchisees orchestrate their exit strategies meticulously, from the overture to the finale. As with passing on the franchise to your heirs, selling your business requires a similar plan — including devising a personal business plan and targeting when and how you will exit the business. In this way, you can continue to have one foot firmly in your business while the other foot is inching towards the door.

Beginning to prepare several years before the target date makes sense. You will want to take steps to boost the value of your business, and doing so takes time. You need to investigate and then select an appropriate sales vehicle. Possibilities include using a sales broker, putting the unit in the franchisor’s resale program, and networking with other franchisees.

After putting the franchise up for sale, it may get swept up right away — or it could take weeks, months, or even years to sell. Of course, as we have noted, the franchisor will have a role approving certain aspects of the proposed sale, especially as it relates to the proposed buyer who will be the new franchisee.

Sprucing up the joint: Getting the most return on your investment

Selling a franchise is very much like selling a house, and that even includes staging. Obviously, you don’t have to light a fire in the fireplace or fill the air with the aroma of freshly baked apple pie. But you want to make your business look, feel, and be at its best before potential buyers cross the welcome mat. Clearly, what you put into the selling process affects what you will get out of it.

The first place to start is your finances. Without question, a prospective buyer’s biggest concern is your business’s financial bottom line. Is the business profitable? The only way a franchisee will know this information is if your books are in tip-top shape.

Allot at least three years of lead time to start keeping accurate records. By accurate, we mean removing personal expenses like the Porsche, artwork, and other personal assets used to minimize taxes off financial statements. Those expenses should not be there in the first place, and of course you would never do that. Nevertheless, the books should reflect only the business’s true expenses and revenues.

Set up records by using generally accepted accounting principles and consider having a certified public accountant prepare financial statements for the business. Try to settle any financial obligations, liens, and claims or lawsuits with suppliers, customers, or other parties. Also, talk to an accountant and attorney far in advance for financial-planning purposes, such as setting up charitable trusts, to account for any post-sales tax.

Have your other papers in order, too. Prospective buyers see value in such things as business plans, employee records, supplier contracts, operational diagrams, and, of course, organized franchise support materials. Keep all the franchisor-provided operations and training manuals, as well as any additional information that may come in handy to the buyer, such as materials from seminars or conventions, surveys, the title, and environmental information.

You’re most likely under a confidentiality agreement with your franchisor. Check in advance about which documents you can share and which you can’t.

Prepare a list, provide that to the prospective franchisee, and consider having them obtain access to that information directly from the franchisor. The franchisor is going to want to meet the buyer before the sale closes anyway, so clearing that hurdle early may make the sales process go more smoothly.

Next, cosmetic changes may be in order. The business already may be in good shape because you were required to meet the franchisor’s standards during the franchise relationship. Still, any business could probably use some spit and polish in some nook or cranny. You should become your own worst critic. Attack things that a customer — and therefore a buyer — would see. Low-cost, routine maintenance pays off here. Consider getting new blinds, paint some walls, and straighten the pantry. Small improvements can have significant benefit to what you get when you sell your business.

Bigger investments take more thought. For example, should the franchisee upgrade equipment or remodel to meet the franchisor’s current standards? Or should you let new the franchisee deal with — and pay for — these modifications? Will the investment or non-investment impact the sales price or the sale? Will the franchisor require modifications to be made as a condition of transfer of the franchise to the buyer?

In the end, much of the prep work in buying a franchise pays off when selling. Site selection was a chore, right? Here’s the payback: Many buyers consider physical location a primary factor in determining value. Real estate leases that have several years remaining and renewal options are attractive selling points; leases on, say, obsolete equipment are not. Remember how much time you spent on employee training? Focus on having the prospective buyer be impressed by your trained staff so they’ll want to keep some of your employees. How about customer loyalty? Supplying the buyer with access to customer contact and marketing data gives the buyer a big head start.

One legitimate concern of a buyer is whether the selling franchisee plans to open a similar business nearby in the near future, potentially competing against the buyer. The point is moot if the selling franchisee is bound by a non-compete agreement with the franchisor (and that is found in the franchise agreement). Otherwise, you can calm the buyer’s fears by offering the buyer a similar non-compete arrangement. You may also want to offer financing assistance or consult or help train the buyer for a specified post-sale period. These latter conditions tie you to the business a little longer, but can be compelling enough to close the deal.

Figuring out how much it’s worth

At this point, you are wondering how much can you get for the franchise and how is that determined? Answering these questions is not easy. In the past, many business consultants and brokers were quick to rattle off formulas, usually based on a multiple of cash flow. Times have changed. Consultants and brokers realize that too many factors go into valuing a business to rely on a cookie-cutter formula. Every business has to be valued by itself.

Here is another reason why cookie-cutter formulas or so-called “rules of thumb” don’t work. Say the valuation is based on gross sales. There is a huge difference between a business that has suffered a downturn in sales — say. going from $1 million down to $500,000 — and a business that’s growing and generating sales, like going from $250,000 in sales to that same $500,000. There is also a big difference between a franchise agreement with 3 years remaining on it and one with 15 years remaining on it. These are just examples, but they are critical to understanding that a one-size-fits-all approach will lose the seller money or result in the buyer overpaying.

Valuations are based on the financial facts of the business, the current state of the industry, the business’s position in the industry, the location of the business, and timing. The key to valuation is that the numbers have to be accurate, and the ultimate value is based on cash flow, assets, and the return on investment anticipated by the buyer.

When franchisees transfer the franchise, many franchisors require the new franchisee to sign a new, current agreement but may not provide a full-term and renewal period(s) as it would for a new franchisee. The agreement is typically modified to provide only the remaining time and renewal periods unexpired from the original agreement. The difference between 3 and 15 years of remaining life can have a dramatic effect on the selling price.

Given the dramatic effect the remaining term of the franchise can have on valuation, determine the franchisor’s position on the length of time available to the buyer of your franchise. Franchisors often consider an early renewal, especially when only a short period of time remains on the franchise agreement, or they’re willing to provide the new franchisee with a full term.

You can ask the franchisor and franchisees what comparable franchises have sold for, but don’t expect the franchisor to help set a price. That could be a conflict of interest, especially if it has a right of first refusal to buy.

Having the business appraised is worth the expense. Seek out an independent, reputable third party that understands franchising to do the valuation. The cost of a valuation depends on the business being evaluated, including the condition of its records, the number of locations, and the purpose for which the appraisal is needed. Prices for a valuation can range widely. Figure that a valuation takes about 30 days and plug that into your exit timeline as well.

Again, as with selling a house, don’t expect the asking price to be the selling price. Be prepared for negotiations, and be willing to compromise. Try to understand the buyer’s motivations and view things from the buyer’s perspective. We know that letting go of a business that you have put your blood, sweat, and tears into is tough, but being calm, rational, and friendly throughout the selling process usually pays off.

Playing by the franchisor’s rules

As we mentioned earlier, when selling a franchise, the franchisee is not a free agent. Even if a buyer makes you a great offer, you can’t formally accept it until certain details are worked out with the franchisor. Most franchisors have a right of first refusal, which means that whenever a prospective buyer makes a bona fide offer to purchase the franchisee’s interest in the franchise agreement or business assets, the franchisor has the right to purchase it on the same terms and conditions within a set time period.

Review the franchise agreement to see what rights the franchisor has reserved for itself, any requirements for notice to the franchisor of possible sale, the form of the notification, and how many days the franchisor has to respond.

In other words, the franchisor may end up buying the franchise. Many franchisees have a problem with this provision, and rightfully so. They feel that such a provision hurts or at the very least interferes with their sales efforts. Consider a sophisticated buyer who spends months checking out the franchise and makes an offer only to lose out on the opportunity to buy the business because the franchisor moves in, matches the price, and buys it right out from under them. Trust us — that potential buyer will not be pleased. Some sophisticated buyers won’t even begin to negotiate or do their due diligence on the business if the franchisor will likely match their offer.

We recommend you discuss this issue with the franchisor and determine what its intentions are before beginning to market the business. If the franchisor decides that it is not interested in executing on its right of first refusal, get it in writing. Such proof will allay a potential buyer’s fears.

Franchisees also need to deal with the franchisor’s right to approve the transfer. Most franchise agreements give the franchisor the right to approve all transfers of ownership. Think of a prospective groom asking the father of the bride-to-be for permission to marry his daughter before he asks for her hand in marriage. Some provisions add that the franchisor can’t unreasonably withhold consent. The word unreasonable can be open to debate, however. Typically, a new franchisee must meet the franchisor’s qualifications, fulfill ownership requirements, such as training and remodeling, and sign a then-current form of franchise agreement.

The franchisor also receives a transfer fee, usually to cover legal and accounting costs. Not all transfer fees are identical, so confirm the exact transfer fee applicable to your deal before negotiating the purchase price. For example, instead of charging a flat fee, some franchisors charge a percentage of the then-current franchise fee or even the sales price. Others reduce the fee if the buyer is an existing franchisee or an employee of the franchisor or franchisee. Transfer fees, training costs, and updating costs can be used in negotiations to affect the purchase price and timing of the deal, for either the selling franchisee or the buyer.

Expect the franchisor to ask you to submit the proposed purchase agreement and to take a look at the purchase agreement generally on these points:

Inconsistencies between purchase agreement and franchise agreement
Debt structure and leverage
Overall viability of transaction
Structure of ownership and operations
Condition of the facility and arrangements for upgrading or repairs

You will need an attorney involved to assist you in structuring and documenting the sale of your business. The franchisor will also want to confirm a few items that directly impact it, including that

Monies owed to the franchisor and its affiliates have been paid in full.
You’ve executed a general release of all claims against the franchisor.
You’ve agreed in writing to comply with all post-sale obligations under the franchise agreement, including non-compete obligations.

Some franchisors recommend or mandate that the selling franchisee remain onboard for a period of time after the sale to smooth the transition to the buyer. Some franchisors require, subject to state law, the selling franchisee to stay on as guarantor of the buyer’s performance under the franchise agreement. The need for such conditions and how well they work out may depend on the experience and skill of the buyer and the personality of the selling franchisee. It’s always awkward to be asked to train or monitor your replacement, and the situation can be more so if the buyer changes your tried-and-true methods for operating the business while you’re still training.

On the plus side, in-house mentoring, consulting, or personal introductions to suppliers and customers by the selling franchisee are valuable and should raise the sales price. Buyers may view a willingness to stay on as a reflection of the selling franchisee’s transparency. And the selling franchisee may gain peace of mind if the buyer is a gem, seeing that the business is in good hands.

Some franchisors are reluctant to get involved in the sale, especially regarding the selling price. If the selling price is high, and the franchisor objects, the selling franchisee may claim the franchisor interfered with the sale. On the other hand, if the franchisor doesn’t tell the buyer that the price is excessive, and the buyer (as the new franchisee) is unable to meet the debt service on the business, the buyer may claim the franchisor should not have approved the deal later on. These scenarios can be troubling.

Many franchisors have worked out formulas concerning debt service–to–cash flow ratios, which they make available to their franchisees who may sell in the future. Although not guarantees, providing this type of guidance can avoid problems later on. Often if the price is high but the amount of cash the new franchisee is willing to invest keeps the debt service low, this will make an otherwise unacceptable deal acceptable.

Selecting a sales method

Okay, this is it. You are ready to let go. You are convinced the timing is right, you know what the business is worth, and you are aware of any obligations to the franchisor. All that is left is actually putting your business on the market.

We suggest that a franchisee not try to market it independently. Doing so is draining. It’s best to leave the marketing and selling the business to a professional and concentrate on running it so you preserve the value of what you’re selling. A logical place to start is to contact the franchisor. Because it typically has the right of first refusal, entitling it to buy the business, checking with the franchisor first makes sense. Selling to a franchisor usually yields the fastest, though not necessarily highest-priced, deal.

Stay alert for signs that the franchisor may be interested in buying your business when the time comes. For example, has the franchisor established a pattern of buying back units? Is it repositioning itself to operate more company-owned units? Is it looking to enter any particular market?

Another reason for contacting the franchisor is that it may offer a franchise resale program. This may be a formal program in which the franchisor will facilitate introductions to potential buyers, or an informal program in which the franchisor generally stays informed about prospective buyers, including new franchisees who want to buy existing units or existing franchisees who want to buy more units. In either case, check to see whether the franchisor charges any fees in connection with the referral. The franchisor normally considers these leads qualified if they’re in its database, which should speed the approval process along.

Here are a few strategies for shopping the franchise:

Don’t rely only on the franchisor to notify existing franchisees. Contact the franchisee advisory council and franchise association if one exists (see Chapter 10). Put out the word on the franchisor’s intranet forums and talk up the business at conventions and other meetings.
Try marketing the franchise on a resale listing service on the Internet. Be careful, though, because this sales technique also makes this information available to your managers and staff. Selling franchisees and brokers pay to post franchises and other business opportunities for sale over specific time periods.
List the franchise with a business broker, the equivalent of a real-estate broker for businesses. Use a business broker with a national and international network, because the buyer may not come from around the corner. If the business broker is familiar with franchises, all the better. Fees vary by location and sales price.

Now That the Party’s Over

You have just completed life as a franchisee. Sounds like the beginning of a movie script. Well, most great flicks usually spawn a sequel. Now you need to write yours. Will Part II be more enjoyable, more adventuresome, more dramatic, more humorous? It can play out however you want it to. Of course, some franchisees may just want to pocket the box-office sales — take the $100,000 or $500,000 or however much they have made from their franchise — and head off to Cancun, indefinitely. But unless they are retirement age, most people get itchy after a while and are ready again to star in a more active role — that is, life after being a franchisee.

Reflecting on the experience

In order to look ahead, look back at the past. Rewinding the experience as a franchisee helps determine whether to do something similar or do something entirely different. So hop on the couch for another self-analysis session. Before buying the franchise, you asked questions to see whether being a franchisee was the right move. (See Chapter 3 to refresh your memory.) Now, based on the experience, revisit those questions and see whether the initial answers really held up. This exercise helps determine what you have learned:

Were you an entrepreneur or a “formula entrepreneur”? Did it bother you to always be concerned about rules, standards, and consistency? Did you have to control many urges to do it the franchisor’s way? Were you devastated any time the franchisor flatly rejected one of your suggestions? Or were you thrilled that the franchisor had a proven system to follow and that it was leading the way?
Were you really a people person? Were you able to coach, motivate, criticize, teach, and praise employees? Or did you avoid confronting employees, disciplining, or enforcing the rules of your organization?
Were you able to independently manage your business on a day-to-day basis? Were you able to keep up the pace and work those long hours? Were you annoyed when you would get called back to the business for an emergency just when you were settling in to watch a Sunday football game? Did you pitch in and mop the floor with a smile on your face when an employee called in sick?
How was your relationship with your franchisor? Were you at loggerheads, or did things run pretty smoothly? Did you get involved with other franchisees and tap into the franchisor’s resources? Did the franchisor come through? Were you a good franchisee?

Making the next move

Football players have hung up their jerseys, lawyers have thrown out their law books, and doctors have put away their stethoscopes — all to become franchisees. No kidding. So, if a franchisee wants to be an ex-franchisee turned football player, lawyer, doctor, or anything else, they should go for it. Don’t be afraid to do something totally different (even without going through a midlife crisis). And just how should new plans be determined? Read on.

Considering the options

Based on your franchise experience, you may want to begin again in franchising. Here are some options:

Becoming a franchisee of the same brand: Maybe you want to relocate to another state or market, buy multiple units, become an area developer this time, or take the concept international.
Switching to another brand: You could stay in the same industry or try a totally different industry. Perhaps you had a retail store before and now you want to try a service business that does not require as much overhead. Check any non-compete clauses before doing anything.

New beginnings also could include the following:

Trading up to be a franchisor: A handful of former franchisees have bought the very franchise companies they were a part of or have become franchisors of different systems. The insight they gained from being on the front lines proved invaluable.
Working for the franchisor: You may want to stick with the same franchise, but work on the inside — at regional or corporate headquarters, for example. More commonly, the reverse happens: Corporate employees become franchisees.
Becoming a consultant: The franchisee may want to compete with your co-author Michael and become a franchise consultant. (Michael was a franchisee and a franchisor before he became a franchise consultant, and now he is a franchisor and a consultant.) Depending on the number of years in the industry and any expertise, the franchisee may have a lot of insight to offer franchise neophytes.

Double-checking the old agreement before moving forward

If a franchisee learns one thing from the franchise experience, it is to always check the rulebook. Well, the rules are no different after having relinquished the title of franchisee. Before planning any next moves, go back to the franchise agreement to see whether any restrictions limit future plans.

Virtually all franchise agreements, subject to state law, have non-compete clauses in effect both during and after the termination of the franchise agreement. Post-term, the franchise agreement usually prevents the franchisee from owning or operating a competing business in a defined geographic area for a certain number of years. Two years is typical. The non-compete provision may cite specific businesses, industry segments, or whole industries. It also may cite specific distances from the original unit you operated, another franchisee’s unit, or a company-owned location, or it may have a blanket restriction.

Whatever your long-term plans, whether you choose to stay the course and continue with your business, expand the business into different cities, or sell and go to Tahiti, the one underlying thing you need to remember is that if you do your homework on the front end, if you understand the franchise agreement, and if you plan for your future, you will have more options and probably a happier future.

When the End Is Nigh