Words of Wisdom from a Franchise M&A Expert
This article was written by attorney Matthew Wizmur.
When people think of due diligence, they think of lists. Just as there is a checklist of tasks to be completed before investing in a single franchise, a transaction involving an entire franchise system is the same, just on a larger scale…with much longer lists.
Due diligence within the franchise industry is complex, but not for reasons you may think. Before we get into the nuts and bolts of what it takes to prepare for the transaction between two parties negotiating a deal for a franchise system, it’s important to remember that there are people behind those nuts and bolts and that there is as much emotion and psychology behind a deal as there is profit and loss.
If I was representing you, the buyer, the first thing I would ask you is “why this business, why this industry?” You should be buying a business that really excites you. Think out loud, hear yourself when you talk about it, and gauge your excitement. It may seem like this exploration of emotions is more suitable for a therapy session than a business deal, but it serves its purpose for both you and the seller. If you aren’t emotionally invested in the business, how likely do you think it is that the seller is going to think you’re a good fit to take over their company?
Think about a franchisor who has spent years, perhaps their entire professional lifetime, building the franchise system you are about to buy. This system is their baby. It’s a representation of their blood, sweat, and tears over years filled with accomplishments and people, and memories. Does that sound like something you would want to hand over to someone who isn’t excited or emotionally invested? There are some cases where the deal is simply that – a deal. But in most cases, we must remember that above all else, franchising is a people business.
And those people have lists.
The to-do list involved with due diligence prior to the completion of a franchise transaction, especially one involving an entire franchise system, isn’t for the faint of heart. This is why there are legal and financial professionals who specialize in franchising who can help you. Franchising is its own industry with its own regulations and compliance requirements, some of which vary from state to state. The financial, legal, and business complexities are vast, but they are also succinct. The good thing about a franchise deal versus an independent one, is there isn’t much gray area.
Now back to those nuts and bolts.
First, you will need to have a clear understanding of the fundamentals. A franchise system listed for sale should be organized. If a system looks more like a cyclone, you’ll want to know what you are getting into. How is the corporate structure set up? Which company holds the trademarks and licensing? Are those up to date and are they fully available as part of the deal? In other words, will the seller be holding on to any aspect of the business, in name, product, or process? You will need to find out about intellectual property and any ongoing litigation. Compliance, or the lack thereof, among the franchisor or its franchisees within the system, is enough to make a deal go south.
Next, you’ll look at the numbers. What financial state is the system in? Your legal and financial team will put an eagle eye to the viability of the system you are about to purchase, as well as note any outstanding loans or debts. This is a crucial step in not only finalizing the overall transaction, but properly representing your new franchise system under Item 19 within the FDD.
You will go through many, many documents. Unlike investing in a single franchise where there is a single Franchise Agreement to navigate, you will need to go through the franchise agreements of each franchisee in the system. In addition to the details, you’ll want to know who the shining stars are, who is struggling or making trouble, and are there any unsettled disputes. Which of them want to expand their territories? Is there room for that, what will their agreement allow? All of which, among other things that you will want to remove or add, will be included in a newly drafted Franchise Disclosure Document so you will be ready to market your new franchise system once the transaction is complete.
Finally, you will explore the relationships the franchisor has developed with people along the way of building their franchise system. Certainly, there are contracts with vendors for supplies and distribution. Those agreements may be national accounts, or they may vary from state to state. You’ll meet the corporate staff, if applicable. Is there a team in place to onboard new franchisees for sales, training, operations, marketing, and other aspects of the business? What will happen to current employees? Remember, franchising is a people business. You may be purchasing a system, but the people and relationships within that system are what keep the system working.
The purchase of a franchise system can be a life-changing decision, or at the very least, a monumental transaction. Transparency and compliance are crucial, but perhaps the most important thing to remember during the due diligence process is that it takes time. You must be patient. The nuts and bolts you are compiling won’t come together quickly, but with the right legal and financial team to guide you, the result will be one you feel great about.