Memo to Franchisors: Help Your Franchisees Plan For Succession

This article was originally published in the May 2006 issue of Franchise Times.

Like it or not, some day, we all will have to think about succession planning. With luck, it will come when we reach retirement age, but for many, that time may come much sooner, perhaps when unexpected personal matters overwhelm us, or when we find our business overwhelming us. Recently, a combination of historically low interest rates, and increasing multiples of EBITDA being reported for restaurant buy-outs, has had many restaurant owners thinking about succession earlier than anticipated.

When a franchisee wants to sell his business, it is his responsibility to find a buyer. You, the franchisor, have your own business to run. However, the decisions the franchisee makes in attempting to sell his business may have a dramatic effect on your business. When a successful operator turns over the keys to the first buyer he finds, your revenue system will be adversely affected. You might even wake up one morning and find a new owner of the business, without ever having known the business was for sale. You can reduce the likelihood of encountering these scenarios by helping your franchisees plan and prepare for the day they will retire from the business. This article will explore three simple steps you can take to help your franchisees plan for the day they will want or need to sell their restaurants, with each step providing collateral benefits to you, the franchisor.

Step 1 - Education

Design training programs aimed at succession planning. They can be stand-alone programs or workshops at your annual franchise conventions. Teach your franchisees what they need to do to prepare their business for sale when they want to sell, such as properly reporting all revenue in the years leading up to the sale so as to improve the financial statements they will be showing their prospective purchasers, upgrading equipment, and making cosmetic improvements to the restaurants. (Do you see the collateral benefits?) Talk to your franchisees about the type of prospective purchasers they should be considering (particularly the type of people you would approve). Educate franchisees as to the time it will take to sell their business, as well as the range of sales price they can expect to receive.

Give your franchisees a checklist of what they need to do once they start the sale process. Include in the checklist the provisions of the transfer clause in your franchise agreements. Remember that while you may have been involved in numerous transactions buying and selling restaurants, most of your franchisees have never sold a business and have no idea what to do or expect. Moreover, the other people who will advise your franchisees may not understand the unique aspects of selling a franchised business.

There are others attending your conventions who should also be targeted for education on succession planning. The most obvious buyers for your franchisees’ restaurants are people already involved in your system; relatives of the franchisees who are already working in the business, the managers of their restaurants (and other restaurants in your system), and neighboring franchisees. Training programs that help family members and managers someday, become business owners will not only help develop prospective buyers for existing franchised restaurants, but they will develop prospects for new units you wish to develop. Programs for individual restaurant operators can prepare them to become successful multi-unit operators.

Step 2 - Direct Assistance

Let your franchisees know that you are available to assist them when the time actually comes to sell their business. If you have had success with particular brokers or investment bankers selling other restaurants in your system, offer the names of these people. Provide samples of business listings used by other franchisees to sell their businesses.

If your franchisees have trouble finding buyers, consider diverting leads from new sales to your selling franchisees. Some leads you receive are simply not interested in building a new restaurant, but are looking to purchase an existing business. Why lose those leads to your competitors? Even in situations where you might be able to sell a new franchise to a lead you generated, if you are faced with the prospect of a franchisee closing his doors because he has not found a buyer, or worse, closing his doors and contacting his lawyer, you might gain more by diverting your leads to solve an existing problem than by having to deal with a “tired unit.”

Once a prospective buyer is found, consider helping your franchisee close the sale. You can validate representations the franchisee made to the prospective buyer. You can also say things to the buyer that the franchisee may not be comfortable admitting, particularly when prior performance has been hindered by “a tired franchisee.” By talking to prospective franchisees, you can also keep them from developing false expectations about the business. In addition, you will have an early opportunity to determine whether the buyer, and the structure of the transaction, meets your requirements.

You must be careful not to incur liability for statements of the franchisee when you get involved in the sale process. However, you can protect yourself through written disclaimers, noting you are not the owner of the business, it is the franchisee that is selling the business, you are not acting as the agent of the franchisee (or visa versa), and you have not reviewed, and are not responsible for, any information the franchisee provides to the prospect.

Step 3 - Taking a More Active Role in the Sale Process

If the first two steps do not result in a successful sale of the business, you can take a more active role in the process. Some franchisors will offer to sell the business for the franchisee. One way to do so is to obtain a contract with the franchisee as the exclusive sales agent to solicit potential purchasers for the business. If you offer that assistance, negotiate in advance a form purchase agreement, detailing the business terms that would be acceptable to the franchisee. To the extent permitted by state law, you could even receive a commission for brokering the sale. A variation of this broker arrangement is to purchase an option to acquire the business. In exchange for a nominal fee, the franchisee gives you an option to purchase the business at a pre-determined price. You then have a period of time, perhaps as long as a year, to look for a buyer. If you find a buyer, you sell the option to the buyer, perhaps at a premium, and the buyer acquires the business under the terms of your option.

If you are in the business of operating company-owned restaurants, the ultimate assistance you can provide to a selling franchisee is to purchase the business. If the unit is under-performing and you can improve operations, purchasing the business for resale could represent a significant profit opportunity for you. Some franchisors have established formulas for purchasing franchised businesses, and all franchisees are aware of the formula so that when they are ready to sell, they have an idea of the value of the business, and a willing buyer at a pre-determined price. Such a practice can give you a built-in means of developing new company-owned stores without assuming the initial development risks. Whether you then operate the business as a company-owned restaurant, or resell it to a new franchisee, may vary with each location.

Conclusion

When a franchisee wants to sell his business and either cannot find a buyer, or has no idea how to proceed, the unit will suffer. That will result in immediate lost revenues to you through a reduction in royalties. It will also result in a lower per unit average revenue figure, which in turn can depress a publicly owned franchisor’s stock price, and any average revenues shown to prospective franchisees in Item 19 of the franchisor’s Offering Circular. As a result, the issue of succession planning for franchisees is not only a franchisee problem, but the franchisor’s problem as well; the cost of having a restaurant unit suffer once the franchisee has “checked out of” the business (or “needs to” check out of the business), is significant to the franchisor. It is therefore far better to prepare your franchisees for this day, and help them, than to be the target of their ire when they feel handcuffed to a business they no longer want to operate.

Reprinted with the permission of Franchise Times, May 2006 © Franchise Times, 2808 Anthony Lane South, Mpls., MN 55418