Selling a Franchise Business: Legal & Financial Considerations

Selling a franchise business involves more than finding a buyer and agreeing on a price. The terms of your franchise agreement, transfer fees, franchisor requirements, and the Franchising Code of Conduct are all relevant to the sale.

In this article, we look at some of the key legal and financial considerations that can affect a franchise sale. If you are looking for the process involved in selling a franchise, see our guide How to Sell a Franchise in Australia.

Legal considerations when selling your franchise business in Australia

There are a number of legal considerations that you need to take into account when selling a franchise business. These include:

• any sale restrictions contained in your franchise agreement;
• the franchisor's right of first refusal;
• franchisor approval;
• transfer and surrender requirements;
• the preparation of a business sale agreement;
• assignment of a lease or licence;
• releases of liability;
• restraints after sale.

Franchise Agreement Restrictions

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.

The franchisor's 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. A right of first refusal can affect the sale process and potentially the price you can achieve for your business. Before marketing the business, check whether you must first offer it to the franchisor and whether the franchise agreement prescribes the price, valuation mechanism or process that applies.

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. Our guide How to Sell a Franchise in Australia, sets out this process in more detail including the circumstances where it is reasonable for a franchisor to withhold consent to the transfer.

Fees under the Franchise Agreement

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 finalised, 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. Purchaser Training Fees: Some franchise agreements require the outgoing franchisee to pay the training costs of the incoming franchisee. If your franchise agreement contains such a requirement, you should speak to the franchisor about these costs, and how much they are likely to be.
   
   
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).  
   
   

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.

Business Sale Agreement

While the business sale agreement will include the normal provisions for the sale of a business, the business sale agreement for a franchise business will also include conditions specific to the franchise sale.

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

1. Conditions Precedent: The sale will normally be subject to the approval of the purchaser by the franchisor, the purchaser taking an assignment of the franchise agreement or entering into a new franchise agreement with the franchisor, and the purchaser taking an assignment of the lease (if any) or entering into a new lease with the landlord (if applicable).
2. Purchase Price: The business sale agreement will outline the total purchase price for the franchise business.
3. 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.
4. 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.
5. 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.
6. 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.
7. 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.
8. 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.

It's important to note that the terms of a business sale agreement can be complex and should be customised to the specific circumstances of the transaction. 

The Assignment of the Franchise Agreement

If the 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.

• the franchise agreement is assigned in the same terms.

• you may still be liable if the incoming franchisee does not perform its obligations under the assignment.

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.

Alternatively, the franchisee will enter into a new franchise agreement with the franchisor. In this situation, the franchisee will enter into the franchisor's current franchise agreement, which may contain different terms to your franchise agreement.

As set out above, the business sale agreement will be subject to either circumstance.

Transfer of the Lease

If the franchise business is operated from a site, you may need to assign the lease (if you are the tenant). Alternatively, the franchisor may enter into a new outlet licence with the franchisee (if the franchisor is the tenant).

You are the Tenant 

If you hold the lease directly with the landlord, you will need to read your lease to check any assignment or approval provisions. 

In addition to the approval of the franchisor, the purchaser may need to be approved by the landlord. Be aware that the landlord may charge a fee to approve the purchaser.

Regardless of whether the lease is assigned or the landlord enters into a new lease with the purchaser, it is important that you obtain from the landlord a release from any obligations under the lease and from any guarantees that have been entered into in relation to the lease.

You do not want the landlord to have any recourse to you if the purchaser does not comply with its obligations.

You should also be aware of any requirements to provide the purchaser with a leasing disclosure statement.

The Franchisor is the Tenant

If the franchisor holds the lease then you are likely to have a sublease or a licence to occupy the premises.

You may be required to transfer the sublease or the premises licence to the purchaser (or alternatively the franchisor will enter into a new premises licence with the purchaser).

Again it is important that you obtain from the franchisor a release of any of your obligations under the premises licence.

Financial considerations when 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.

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.

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. 

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 and an approval 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

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.