Navigating the Legal and Financial Aspects of Selling your Franchise Business in Australia

Selling a franchise business in Australia can be a complex process, especially when it comes to understanding the legal and financial aspects involved.

In this article we'll explore how to navigate the legal and financial aspects of selling your franchise business in Australia. From understanding how the Franchising Code of Conduct and your franchise agreement apply to the sale as well as considering the value of the franchise business, we will provide you with information that will help to make the journey smoother.

Understanding the Legal Aspects of Selling Your Franchise Business In Australia

The rights to sell a franchise business in Australia  will depend on the terms of the franchise agreement, the operations manual and the Franchising Code of Conduct (the Franchising Code).

1 - Franchise Agreement Terms and Conditions

One key area to explore is the terms and conditions of your franchise agreement, as they may have an impact on the sale of your franchise business.

To help you navigate this process, we have outlined some of the most common terms that are typically included in a franchise agreement relating to the sale of your franchise business.

a -  Right of First Refusal

In some franchise agreements, there is a provision known as the "right of first refusal." 

The "right of first refusal" means that before you can sell your franchise business to someone else, you must first offer it to the franchisor. The franchisor may have the option to purchase the business themselves, at the price offered by a prospective purchaser, at a predetermined price, or according to a specific formula.

However, if the franchisor chooses not to exercise their right of first refusal, you are then free to sell the franchise business to a third party, as long as you meet certain conditions, including the approval of the purchaser by the franchisor.

b - Approval of the Purchaser

If the franchisor does not wish to purchase your franchise business, in order to sell your franchise business, the potential purchaser must be approved by the franchisor. This ensures that the new owner meets the requirements set by the franchisor.

The franchisor cannot unreasonably withhold consent or approval.

What is considered reasonable or unreasonable will vary depending on the individual circumstances of each case.

The Franchising Code sets out a number of circumstances in which it is reasonable for the franchisor to withhold consent or approval. These include if:

• the potential purchaser is unlikely to be able to meet the potential financial obligations under the terms of the franchise agreement;
  
  
• the potential purchaser does not meet the selection criteria of the franchisor;
  
  
• the potential purchaser does not meet a reasonable requirement of the franchisor. 

c - Fees

Your franchise agreement will also contain details of some of the fees that are required to be paid on the sale of your franchise business. You should be aware of these fees before you set the sale price for your franchise business.

1. Transfer Fee: A transfer fee is the fee that is paid to the franchisor on the sale of your franchise business. The transfer fee may be a percentage of the sale price or may be a fixed fee.
   
   
2. Franchisor Approval Costs: Before the sale can be finalized, the franchisor may require the purchaser to undergo a vetting process in order to obtain their approval. The franchisor might charge a fee to cover the costs associated with reviewing the purchaser's qualifications, financial standing, and suitability to operate the franchise. 
   
   
3. Legal Fees for Surrender: A franchisor may require a franchisee to enter into a Surrender Deed or Surrender Agreement on the sale of the franchise business. The franchisor will usually charge a fee for the preparation of the Surrender Deed or Surrender Agreement.
   
   
4. Retention Amount: While a "retention amount" is not a fee in itself, some franchise agreements require the franchisee to pay an amount to the franchisor which the franchisor will hold to cover any expenses that the franchisor may incur (in relation to the sale of the franchise business or the ending of the franchise agreement). The balance of the retention amount is then refunded to the franchisee after a pre set period (generally 3 to 6 months).  
   
   

2 - The Franchising Code of Conduct 

There are provisions in the Franchising Code which apply to the sale of a franchise business.

As we have set out above, the Franchising Code sets out a number of circumstances where it is reasonable for a franchisor to withhold consent or approval of a purchaser.

In addition, the Franchising Code also provides that if you have requested in writing that the franchisor consent to you transferring the franchise to a third party and the franchisor has not:

• given their consent to the transfer within 42 days after the request is made; or
  
  
• given their consent to the transfer within 42 days after the franchisor has sought any further information about the potential purchaser

the franchisor will be taken to have given their consent or approval.

3 - Transfer of Franchise Ownership

If the franchisor approves the potential purchaser you will need to prepare a business sale agreement for the transfer of the business and the assets.

a - Business Sale Agreement

The business sale agreement for a franchise business will include conditions specific to the franchise sale. However, the sale will not involve the transfer of any intellectual property owned by the franchisor. Instead, either the franchisor will require your franchise agreement to be assigned to the purchaser, or alternatively, the purchaser will need to enter into a separate franchise agreement with the franchisor.

We have set out some common terms that are typically included in a business sale agreement:

1. Purchase Price: The business sale agreement will outline the total purchase price for the franchise business.
2. Assets and Liabilities: The business sale agreement will specify which assets and liabilities are included in the sale. This may include tangible assets (such as equipment, inventory, and property). The sale of a franchise business will not include the transfer of intellectual property (including business names) as the intellectual property belongs to the franchisor.
3. Representations and Warranties: You and the purchaser will make certain representations and warranties about the business during the negotiation of the sale. Representations and warranties included in the business sale agreement affirm the accuracy of the information provided by you and the purchaser and the legal and financial status of the business.
4. Due Diligence: The business sale agreement may outline the scope and timeline for the purchaser's due diligence process. This allows the purchaser to investigate the business's financial, operational, and legal aspects before completing the purchase.
5. Non-Compete and Non-Disclosure: Given that the franchise agreement (and possibly the Surrender Agreement) will contain non-compete provisions, these provisions do not need to be additionally included in the business sale agreement. Further, while the business sale agreement may include some non-disclosure provisions, provisions relating to trade secrets and intellectual property will also be covered by the franchise agreement.
6. Indemnification: The business sale agreement may include indemnities, which define the responsibilities of each party in the event of a breach of the business sale agreement or the occurrence of specified liabilities or damages.
7. Conditions Precedent: The business sale agreement may include conditions that must be fulfilled before the sale can be completed. These conditions may include obtaining necessary approvals, securing financing, or satisfying specific contractual obligations such as the approval of the purchaser by the franchisor or the entry of the purchaser into a franchise agreement with the franchisor (or alternatively the assignment of your franchise agreement to the purchase).  If the conditions precedent are not fulfilled the business sale agreement may be terminated.

b - The Assignment of a Franchise Agreement

The assignment of a franchise agreement involves the transfer of your rights and benefits under the franchise agreement to the purchaser of the franchise business. Consequently if a franchise agreement is assigned, the purchaser franchisee is given the right to use the franchisor's intellectual property and business systems for the remaining term of the franchise agreement.

Importantly, the purchaser is not required to enter into a new agreement. Instead, the assignor must simply document the assignment in writing, sign it, and give written notice to the other party involved. The franchise agreement is assigned in the same terms.

The assignor cannot pass on their responsibilities or liabilities under the franchise agreement. They are still obligated to fulfill their part of the contract. The person receiving the assignment can enforce their right to the benefits, but they are not considered a party to the original contract.

Consequently, if your franchise agreement provides that the franchise agreement is to be "assigned" if you sell your franchise business, you should ensure that the franchisor releases you from your obligations under the franchise agreement.

c - New Franchise Agreement

Instead of an assignment, your franchise agreement may provide that any sale of the franchise business is subject to the purchaser franchisee entering into a franchise agreement with the franchisor.

In this situation, the franchisee will enter into the franchisor's current franchise agreement and the purchaser franchisee may be required to pay different fees to the fees that you have paid while operating the franchise business.

The current franchise agreement may also contain different terms to your franchise agreement. 

Managing the Financial Aspects of Selling Your Franchise Business in Australia

In addition to understanding the legal aspects of selling your franchise business, selling a franchise business also involves managing various financial aspects.

1 - Valuing Your Franchise Business

Determining the value of your business can be a complex task, but there are benchmarks available in many industries to provide a general idea. These benchmarks are typically expressed as multiples of revenue or multiples of EBIDTA (earnings before interest, depreciation, taxation and amortisation) income.

However, many factors can influence the sale price of a franchise business. Here are some key considerations:

1. Brand Value: The strength and recognition of the franchise brand can significantly impact the sale price. A well-established and highly regarded brand can usually command a higher price because it comes with built-in customer loyalty and market presence.
2. Financial Performance: As we have already mentioned, the financial performance and profitability of your franchise business play a crucial role.
3. Location: The location of the franchise business can have a substantial impact on its sale price. A prime location in a high-traffic area or an area with significant growth potential can increase the value.
4. Lease Terms: The terms of the lease agreement for the franchise location can affect the sale price. Favourable lease terms, reasonable rent, and renewal options, can make the business more attractive to buyers and potentially increase its value.
5. Market Conditions: The overall market conditions and industry trends can influence the sale price. A thriving industry with high demand and growth potential may lead to higher valuations, while a declining market may reduce the sale price.
6. Franchise Agreement: The terms and conditions set out in the franchise agreement can impact the sale price. Factors such as ongoing royalty fees, advertising contributions, transfer fees, and renewal terms can affect the perceived value of the business.
7. Operational Systems: The effectiveness and efficiency of the franchise's operational systems, including processes, training programs, technology, and supply chain management, can impact the sale price.
8. Competition: The level of competition within the market for the franchise business can influence the sale price. If there are few similar franchise opportunities available, the value may be higher. Conversely, if there is intense competition or market saturation, the price may be lower.

It's important to note that each franchise business is unique, and the specific combination and weight of these factors may vary based on individual circumstances and the industry in which the franchise operates.

For accurate pricing and valuable guidance, we highly recommend consulting with experienced business valuers. They can assess the true value of the business and provide expert advice for your next steps.

2 - Tax Implications of Selling a Franchise Business

You should consult a tax adviser to let you know the tax implications of selling your franchise business, including capital gains tax and any applicable exemptions or deductions. 

3 - Costs and Fees

We have set out above some of the fees that may be included in your franchise agreement and payable on the sale of your franchise business including a transfer fee, approval fee and Surrender Agreement fee. However, these are not the only fees that may be payable when you sell your franchise business.

1. Lease Assignment Fees: If the you operate from commercial premises, the landlord may charge fees for the assignment of the lease to the new purchaser. These fees vary depending on the lease terms and the landlord's policies.
2. Legal and Professional Fees: Engaging legal and professional services, such as lawyers or accountants, is common during the sale of a franchise business. These professionals assist with due diligence, drafting agreements, reviewing documents, and providing advice throughout the transaction. 

Takeaways

Selling a franchise business can seem daunting; however, being organised and well informed will assist you with getting the most from the sale of your business.

It is important to be aware of the legal and financial aspects of selling your franchise business in Australia, such as understanding your franchise agreement terms, familiarising yourself with the Franchising Code of Conduct and completing a thorough business valuation to receive a fair price for your venture. 

It is also advisable to obtain professional advice:

• on how best to value your business,
• on any tax implications of your business sale;
• to prepare your business sale agreement; and
• to review any documents provided to you by the franchisor (such as the surrender agreement). 

Disclaimer
The information in this article is general in nature and is not intended to address the circumstances of any person or other entity. Although we do our best to provide timely and accurate information, we do not guarantee that the information in this article is accurate or that it will continue to be accurate in the future.