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Instant Franchisor Part II

Your guide to negotiating the purchase of and transition to a new franchise system

Editor's Note: This is the second article in a two-part series on how to acquire a franchise system.

In last month's article , we talked about the process of identifying a franchise company to purchase and completing the due diligence necessary to assure you that the company in question will meet your goals and is fairly valued. Once you've identified this franchise company, however, you may find you have only begun the process of acquiring the company.

One of the first and most significant issues you'll address is the transition plan. In essence, this transition plan focuses on the tactical issues that you must take handle after the transaction is consummated.

Of primary importance in this transition plan is the method for how management and staff are handled following the sale of the company. Will key managers stay with the business long term? Or will there be a transition to a new management team over time? Will you need to hire to achieve the new growth plan? Or will you be reducing staff and assuming certain responsibilities within an outside organization?

While these transition plans are being drawn up, you must also take certain steps to assure a smooth transition on the assumption that the sale will be consummated. For example, the prudent buyer does not want the franchise organization to suspend franchise sales for any length of time following the sale. Thus, you may want to begin developing a revised Uniform Franchise Offering Circular that will be "on the shelf" once the sale is completed--limiting post-acquisition requirements to the development of a newly audited financial statement.

As negotiations progress, both the buyer and the seller need to give some consideration as to when (and how) it is appropriate to disclose the nature of the pending transaction to employees, franchisees and franchise prospects. While there are no hard and fast rules in this regard, it is important that the franchisor (or its management team) not make any promises or representations that run contrary to the views held by new management.

After the Sale

Once the transaction is finalized, you must be prepared to address a number of key issues almost immediately.

Perhaps the most pressing issue is with existing management and staff--especially those who were not privy to the existence of the sales negotiations. These employees will be understandably concerned about their status and future with the organization, and, absent prompt and meaningful communications with new ownership, these valued employees might quickly begin looking for their next career move.

The fact is that in many acquisitions, some members of the existing staff may be assigned to different job functions or may be terminated as functionality is consolidated. In these situations, it is important for you to have a good understanding of this post-acquisition plan prior to the time when the transaction is finalized. The decisions made in this regard should be communicated to employees as quickly as possible to avoid unnecessary angst. And, of course, any terminations should be made with compassion. The extent to which you can help with severance and/or outplacement assistance will generate goodwill with the employees who remain.

In addition to making these moves quickly, you should do so only once and be done with them. Eliminating staff positions over any extended period of time will leave the remaining employees with a sense of impending doom that could well motivate them to look elsewhere, or, at a minimum, reduce morale.

Likewise, as soon as the acquisition becomes public knowledge, franchisees will have a number of concerns of their own.

In some instances, franchisees will be happy to see new ownership and a new direction for the franchise company. You may well bring additional financial and human resources to the table, and may help the franchisees grow in other ways as well. You should have a plan in place to communicate this "value proposition" to the franchisees.

On the other hand, franchisees will likely look at any new buyer with some degree of trepidation. In addition to representing the unknown, the franchisee will generally expect you to bring changes to the organization. To the extent that this will involve stricter enforcement of existing rules (eliminating lax reporting standards and lax performance standards, etc.), you should clearly communicate new policies early in the process. Of course, you should attempt to do so in a way that emphasizes how the system as a whole will benefit.

In the process of implementing these changes, of course, you will likely find that what benefits the system as a whole may not necessarily benefit each individual franchisee. Franchisees that are forced to remodel, for example, may not see the benefit in investing in upgrades if they are close to the end of the term on their agreement. And some of these franchisees may choose to try to test your resolve early in the process. At the same time, you may find that some of the best franchisees may be your biggest ally when it comes to upgrading system standards--as these franchisees may feel it is "their" brand that is being improved in the long run.

While every franchise acquisition is different, as a buyer, you will never go wrong if you follow two simple rules: Have a plan, and communicate honestly and as openly as possible once the acquisition is completed. While these rules cannot guarantee a successful acquisition, they will almost certainly ease the transition when you step into your position as the new owner of the franchise company.

Negotiating the Purchase

Before due diligence is completed, the buyer and seller need to negotiate a selling price for the business. The first step often involves the negotiation of a confidentiality agreement that allows the seller to share confidential information with the buyer, as both parties negotiate a selling price in good faith.

Numerous factors affect the selling price of the franchise company, including the size of the company, corporate assets, earnings, revenue and earnings growth, the make-up of earnings, the strength and value of the brand and the strategic "fit" offered by the selling company (for example, does the franchise company provide the seller an opportunity to develop a captive channel of distribution?).

There are three basic approaches to valuing a business: asset-based approaches, use of market comparables and a discounted cash flow approach. Valuation professionals employ all three methodologies (or variations on these methodologies) to determine what a business is "worth." But ultimately, whenever the sale of a business is concerned, the value of that business is what a buyer is willing to pay a seller. And often, that is where the fun begins.

In addition to determining the selling price, the buyer and seller must also agree to the terms of the sale--and these terms can be more important than the selling price itself. And of course, the selling price is often complicated by a number of additional factors, including financing, covenants and your need for a variety of representations and warranties.

Representations and warranties are your means of obtaining assurances from the seller relative to the nature of the business and the assets being purchased. While there are no legal requirements that the seller provide any representations or warranties, a wise buyer will minimally require some assurances that there are no "skeletons in the closet." Just a few of the typical representations and warranties asked for by sophisticated buyers include asset ownership, tax liability, accuracy of financial statements, the existence or possibility of litigation and the franchisor's compliance with various laws.

And, of course, while all this is being finalized, you will begin conducting your due diligence, arranging financing and developing your "transition plan."

Mark Siebert is the CEO of the iFranchise Group, a franchise consulting firm that has worked with 98 of the nation's top 200 franchisors. He can be reached at 708-957-2300 or at info@ifranchise.net.
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