‘What is my exit strategy?’
Apart from “How much money can I earn?” one of the most common questions asked by prospective franchisees is, “What will be my exit strategy?” There are many reasons for realising one’s asset: including personal reasons, and not everyone is made to be a career franchisee.
We are assuming that the franchise business is a going concern, rather than the franchisee being in default. In the latter case, the franchise agreement may be terminated and the franchisor permitted by the agreement to take over the business.
Where to turn for help
If a franchisee decides to exit, there are a number of people who can assist them in the first steps:
- The franchisor – the franchisee’s right to sell the franchise will be governed by the transfer provisions in their franchise agreement.
- An accountant who specialises in franchise work – one of the first steps will be determining the value of the business, of which there are a number of methods:
- Discounted cash flow: the present value of a business’s future cash flow, discounted according to the risk involved in purchasing the business
- Capitalisation of earnings: a business’s future profitability, accounting for cash flow, annual ROI, and expected value
- Asset-based valuations: the net value of a business’s assets, both tangible and intangible, minus liabilities.
- Market-based valuation based on the purchases and sales of comparable companies within the same industry
- A business broker who specialises in selling franchises – in this regard, you can more conveniently advertise on Which Franchise under ‘resales’.
- Speak to other franchisees who have sold their businesses recently to acquire successful tips.
- The documents that you would require for the sale include:
- at least two years’ financial statements prepared by your accountant
- Recent management reports prepared on the franchise accounting system
- Two years’ VAT returns
- Franchise agreement
- Lease agreement
There will be limitations
The nature of franchising means that most franchise agreements will contain limitations on the franchisee’s free ability to sell their franchised business. That’s why you got into franchising in the first place – the franchisor has final say over who gets to do business under its name and using its proprietary system and methodologies.
The typical restrictions on sale of a franchise include:
- The franchisor may have a right of first refusal for the franchisor to buy back the franchise. This provision states that if the franchisee finds a bona fide purchaser, the franchisor can step in and buy the franchise on the same terms that were offered to the third-party buyer.
- Any potential purchaser must meet the franchisor’s qualifications for new franchisees.
- Any potential purchaser must be prepared to sign the franchise agreement.
- You must correct all defaults (including payment defaults) under the franchise agreement ahead of the sale.
- You may have to sign a general release waiving all potential lawsuits against the franchisor.
- The franchisor will have to approve the financial terms of the sale.
Potential obstacles include the potential purchaser not meeting the franchisor’s qualification criteria, in which case the sale will not move forward; or if the buyer is financing a substantial portion of the purchase price, this too may cause concern for the franchisor. The franchisor will want to ensure the buyer can meet its financial obligations under the franchise agreement and is not overextended as a result of the loan.
The upside of selling a successful franchise is that the valuation of the business will reflect on its success, therefore a franchisee has the potential to sell a franchise for substantially more than it was purchased.