Introduction to Practical Problems and Issues Associated with Buying or Selling a Franchise Company

AuthorHarris J. Chernow and Charles S. Modell
A. Overview
As franchise systems have matured in the last couple of decades, there
has been a signicant increase in the number of franchise companies that
have changed hands. These transactions often represent opportunities
for sellers to cash out of their investments at signicant prots, and for
buyers to take these companies to another level. However, there are a
litany of issues and potential problems associated with an acquisition
of a franchise company, many of which are not found in the purchase
and sale of other businesses. This chapter provides a general overview
of some of the special considerations and issues to address when pur‑
chasing or selling a franchise company. It focuses on the unique issues
in connection with mergers and acquisitions of franchise companies,
including issues relating to franchise‑specic laws, potential causes of
action available to franchisees, key provisions to examine when review‑
ing franchise agreements, franchise disclosure issues with respect to
the transaction, and drafting considerations.
Many of the challenges that apply to selling a business of any nature
also apply to a franchise acquisition, but a number of nuances are unique
Introduction to Practical
Problems and Issues Associated
with Buying or Selling
Harris J. Chernow and Charles S. Modell
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to the acquisition of a franchise company. All too often, attorneys (and others) in
franchise acquisitions lack a “real” understanding of the nature and complexities
of a franchise business, and treat the transaction just as they would any other
acquisition. This can result in problems that could likely have been avoided if
they were properly addressed at the outset. Proper planning and understanding
of franchising’s unique challenges can help the process proceed more smoothly
and lessen some of the inherent risks.
Buyers must be aware of the differences between having franchisees and hav‑
ing company‑owned operations, as well as the laws that regulate franchising.
Restrictions inherent in the franchise business model may not be consistent with
the growth plans of the buyer. For example, a buyer planning to expand the sys‑
tem by quickly replacing underperforming franchisees needs to understand the
impediments in doing so, both in terms of the franchise agreements and the laws
that regulate termination in a number of states. Similarly, a buyer with a sales
background outside the franchise arena will have to adapt to the concept of being
required to deliver a franchise disclosure document to prospective franchisees
and waiting two weeks before closing a sale. Furthermore, these buyers, who
often have business plans and nancing covenants requiring signicant growth,
may not appreciate the concerns that existing franchisees have about how the
transaction will impact their business.
B. Motivations of Buyers
Generally, there appear to be four types of buyers for franchise systems. First,
there is the entrepreneur that can represent the next generation in the life cycle
of a business system. Second, there is the buyer looking to use the franchise sys
tem as a distribution network for its products and services. Third, there is the
competitor seeking to obtain additional market share through the economies of
scale in acquiring a direct competitor. Fourth, there is the buyer who already
operates franchise systems, often in industries or market segments different
from that of the target franchisor. Each of these buyers faces different issues in
an acquisition and presents different challenges to a seller.
Manufacturing and distribution companies have acquired franchise systems as
an attractive way to exploit an alternative channel of distribution or to enhance
their own distribution facilities and marketing expertise. They may see the acqui
sition of an established franchisor as facilitating entry into an alternative channel
of distribution at a lower cost than developing a new franchise concept, building
franchise sales and support infrastructure, and assembling an experienced man‑
agement team. These buyers were particularly aggressive in the 1980s. An example
was in the real estate industry, where buyers did not necessarily appreciate that
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franchisees are independent business people who may have signicant discre
tion in determining which products to purchase and promote. Sears bought
Coldwell Banker to help it sell appliances and insurance products to new home
buyers (through its insurance subsidiary, Allstate) but the Coldwell Banker fran‑
chise agreements did not require agents of the real estate broker to recommend
insurance products to their customers, let alone a particular brand of insurance.
Control Data Corporation acquired Electronic Realty Associates hoping to sell
business computers to franchisees, but could not force anyone to buy the Con‑
trol Data brand of computer when there were competitive brands available. Thus,
while franchise systems can provide great synergy for companies with synergis‑
tic products and services, if these buyers are inexperienced in franchising, they
can be disappointed and frustrated when they nd there are both practical and
legal limits on their ability to sell their products and services to franchisees and
customers of their franchisees.
Strategic buyers who operate competitive franchise systems often have radi‑
cal plans to change the franchisor’s concept. They may intend to integrate the
target’s franchise system into their own, or vice versa. They need to take into
account not only the free will of franchisees who may have views that are incon‑
sistent with theirs, but the very real emotional difculties franchisees may have
when they nd “their” system is suddenly being acquired by a company they
competed against for years. Likewise, culture shock can occur when a system is
sold by an individual or small company that operated as an entrepreneur able
to make on‑the‑spot decisions, to a larger “conglomerate,” with various layers of
management and a bureaucracy that responds much slower.
A prudent buyer should also anticipate the public reaction to the acquisition,
which might affect the business’s future, particularly when the buyer intends to
make signicant changes to the system. In today’s world of social media, many
brands go to great lengths to establish followers, and many of these followers
can become as parochial about the brand as the owner of the brand. A national
company acquiring a regional brand will often discover negative public reaction
because the system was a “favorite son” in the seller’s region, and the loyal cus‑
tomer base is reluctant to patronize “just another” national brand.
Franchisors often choose to expand by acquiring competitors, not only as
a means of expansion, but as a way to “eliminate” the competition. Buyers
may view the acquisition of a franchised business that it is already familiar
with and that it can integrate into the existing system as the easiest way to
expand. Transactions that t this mold include Cottman Transmission Systems,
LLC acquiring AAMCO Transmissions, Inc., and America’s Favorite Chicken
Company (AFC Enterprises Inc.) acquiring Church’s Chicken to supplement
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