When you invest in a franchise, at some point you will need to sell the business. So when is an opportune time, and what should you consider?

A franchise is a licensed contractual right which is not necessarily transferable unless there is a provision in the franchise agreement to transfer and/or novate those rights.

Novation is the substitution of a new contract for an old one whereby the new agreement extinguishes the rights and obligations that were in effect under the old agreement. 

The Franchising Code of Conduct requires that franchisors disclose whether a right to transfer a franchise exists and, if so, the conditions of transfer.

Even if there is no express provision for transfer in the agreement, a franchisee may still request the franchisor consent to a transfer; however there is no contractual obligation on the franchisor to consent.

The Code provides that a request for franchisors consent to transfer or novation of a franchise must be made in writing. It does not expressly require that there be a right to transfer or novation in a franchise agreement; it is often just assumed by franchisees that such a right exists.

The Code of Conduct is a mandatory Code and franchisors can not contract out of the Code. Careful attention should be paid to the grounds for refusal to make sure they are reasonable, complies with the Code and that any first right of refusal to the franchisor is on no less favourable terms than a third party is prepared to offer.

Generally most franchise agreements provide a procedure which allows for the franchisee to sell the franchise subject to the franchisors approval and a first right of refusal.

Is there a good time to sell your franchise?

Franchise agreements run for all sorts of terms and under the Code there is no requirement for the franchisor to grant any minimum term. So a franchise right can be granted for 12 months, three years or 20 years. 

There is also no obligation in the Code for a franchisor to grant a further term or option to the franchisee.

Selling a franchise within the first two or three years is not an opportune time to sell and is likely to crystallise a loss to a franchisee. 

Most business plans provide for a return on investment (ROI) to a franchisee after three or four years. The upfront capital costs of entering into the franchise are generally amortised over the first two to three years. 

It is unlikely that a franchisee will be able to ask for any good will or be able to obtain a return on their capital costs if they sell in this period, although that will depend on the nature of the franchise.

A franchisee with a trading history and financial statements that are up to date and provide for a reasonable wage to the operator – and a profit – will have something to offer a prospective purchaser.

What is my business worth?

Franchisees should understand the basic principle of franchising:

• that the good will built over time by the franchisee is really that of the franchisor, as the franchisee is trading on the franchisor's brand and system.

The franchisee is granted a licence (a contractual right) to operate the business under that brand and system. The good will at the end of the franchise term remains that of the franchisor.

Any good will that a franchisee can recover on sale will be dependant on:

• Whether the value of the franchise system as a whole has increased over time
• Whether the individual business itself is profitable
• The vendor may ask for a multiple of its profit which may vary from the previous years net profit, the average of the last two or three years net profit, or a multiple of three to five years

There are other valuation models that can also be used. At the end of the franchise term, if there is no further option, the licence ends. The franchisee is required to de-brand. In that event the only obligation on the franchisor is to pay the franchisee the depreciated or written down value of the franchisees plant and equipment and stock.

There is no obligation on the franchisor to buy back the business from the franchisee or recognise any good will that may have been built by the franchisee over time.

Is a franchisee entitled to renew for a further term? 

Franchisees should also not assume that the franchisor will grant the franchisee a new franchise agreement for a whole new term at the end of their franchise or in the event they sell the business. There is no such obligation under the Code nor in franchise agreements that give that right.

It is therefore best to communicate with the franchisor before placing your franchised business on the market for sale, clarify the franchisors policy and position to your sale.

Will they agree to grant a new franchise to the purchaser or will they only agree to transfer the unexpired term of your franchise?  This can be a critical question that will impact on the value of your business.

So when should I sell my franchise?

The Code provides that if a franchise agreement is for a term of six months or longer, the franchisor must notify the franchisee at least six months before the end of the term of the franchisor’s decisions to renew or not to renew the franchise agreement or to enter into a new franchise agreement.

Many updated disclosure documents now meet that requirement by simply indicating that there is “no right to renew” the franchise agreement at the end of the term without any further notice being provided by the franchisor.

The best time to sell your franchise business is shortly after renewing the franchise agreement, while you may still have a reasonable term left. However if you only have two years left of your franchise term without knowing the franchisor's position then you have little to offer a buyer. 

Don’t expect the franchisor to be co-operative if you are in default of your obligations at the time of your sale. Also don’t overlook your lease term. If the franchisee holds the lease, how much is left on the lease term as opposed to the term on your franchise. They often are not the same.

The costs of selling your franchise

Before starting the selling process, ensure you understand the cost and exit fees so that those can be taken into account in your negotiations with a prospective buyer. 

The costs of selling can be considerable including:

• business agents fees and advertising;
• landlords costs to approve the incoming franchisee;
• the franchisors costs which can be a fixed fee or a percentage of the sale price;
• Capital Gains Tax on eventual sale

In summary

Plan to sell your business, do your homework, get expert advice from a franchise lawyer and your accountant and identify the issues, costs and process.

Don’t accept the first purchaser that comes along. Do your due diligence on them just as the purchaser will undertake their due diligence on you.

Will the franchisor approve the prospective franchisee? Do you think the purchaser will be able to successfully complete training? Does the purchaser have the capital to acquire the business? Do they need to obtain finance? If so, how much?

By asking these questions at the earliest opportunity you may save yourself time, costs and considerable disappointment.