Buying an existing restaurant offers many advantages of building a new restaurant from the ground up. If that restaurant is a franchised, however, you are engaging in two separate but related transactions: buying an operating restaurant from the current owner, and buying franchise rights from a franchisor. If you are the buyer or seller in this situation, keep in mind these additional legal issues:
- Franchisor’s Approval Process. The seller’s franchise agreement will prohibit selling the restaurant without the franchisor’s prior approval. Before the seller markets the business, he or she should contact the franchisor and obtain information about the franchisor’s transfer process. A good franchisor will have a clear, written process for you to follow in connection with the sale of the franchise.
The seller should alert the franchisor when a letter of intent if signed. The buyer and seller will want to ensure that the franchisor will approve the buyer and the proposed purchase, as well find out any conditions the franchisor will impose for its approval.
- Transfer Fee. The franchise agreement will typically require payment of a transfer fee to the franchisor. This can be $10,000 or more. The buyer and seller need to decide who pays the fee.
- Brand Compliance; Remodeling. Generally, the buyer needs to know if the seller is in compliance with all of the franchisor’s brand requirements, and the parties need to allocate the costs of bringing the franchised business in compliance.
More specifically, if the restaurant does not conform the franchisor’s current “brand image” for new restaurants, the franchisor will often require the seller or buyer to “reimage” the business to the current brand image. The buyer and seller need to understand what is required, the cost involved, and who will bear the cost.
- Training. If the buyer is new to the franchised brand, the buyer will usually need to attend and complete the franchisor’s training program. This will affect the length of time between signing a purchase agreement and closing the sale.
- New Franchise Agreement. The franchisor will often require the buyer to sign the then-current form of franchise agreement, rather than allow the buyer to take over the existing franchise agreement. The buyer needs to be aware of any material differences in the current form, including new or higher fees. Unless the franchisor is actively encouraging the sale, the buyer will usually not have any leverage to negotiate changes to the franchise agreement.
If the seller had a special arrangement with the franchisor, such as lower royalty rates, then the losses of these special arrangements will affect the value of the business.
- Franchise Expiration. The buyer needs to understand if they are taking over the franchise for the remainder of the existing term, or if the buyer is receiving a new 10-year term (or whatever term is standard for the franchise).
- Lease Expiration. If a franchisee leases its restaurant location, there is often a mismatch between the expiration of the franchise agreement and the expiration of the lease term. The problem can be even worse when the franchisor requires the buyer to sign a new franchise agreement. If the new franchise agreement has a 10-year term but the business lease has only seven years left, the buyer will need to negotiate an amendment to the lease.
- Marketing Funds. If the franchise system has a regional or local marketing fund or cooperative, the buyer and seller will need to address what will happen to any unspent funds. Some franchisors will take the funds for their own use. Other may allow the buyer to take over any unspent marketing funds.