What You Need to Know About Franchise Asset Purchase Agreements
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The following excerpt is from Rick Grossman’s book Franchise Bible. Buy it now from Amazon | Barnes & Noble | iTunes | IndieBound
The sale of your franchised business to a third party requires that you enter into special contracts with them. The most common method involves transferring only the assets of your business (including all pieces of furniture, fixtures, equipment and other goods you use to operate the business) along with the business goodwill as a continuing commercial venture and the right for the buyer to continue the business (subject to the franchisor’s approval).
This sales method is accomplished through the execution of an asset purchase agreement, in which you agree to sell all the assets of your business to a third party. Under the asset purchase agreement, the purchaser is only purchasing the assets, goodwill and right to operate the business -- but none of the liabilities (except for the assumption of the franchise agreement). The vast majority of franchise transfers are done through the use of the asset purchase agreement because most buyers have no interest in taking over the seller’s liabilities.
There’s no set form for an asset purchase agreement, though as with the franchise agreement, all such agreements will have common elements, including the following:
Names the parties to the transaction. The “Seller” is the franchisee, and the “Purchaser” (or “Buyer”) is the third party.
Often a contract will contain Recitals, which are usually a series of paragraphs that identify what each party’s position is in the transaction and that acknowledge that the Seller is a franchisee of the franchise system. These paragraphs aren’t considered part of the binding covenants unless they’re later “incorporated” into the contract by language to that effect.
The description of the assets should be a complete statement of what’s being included in the sale. This will include not only hard assets (tables, chairs and inventory) but also any “soft” (intangible) assets that aren’t otherwise owned by the franchisor. Remember that your business is identified with the franchisor’s Marks and intellectual property. Although you can transfer your limited rights to the franchise agreement (indeed that will be one of the items described as an asset), you’re not transferring any ownership rights in the Marks or intellectual property.
Statement of the liens or encumbrances that secure the assets
In some cases, you’ll have purchased the franchise with a business loan. In that case, the lender will have placed a lien against assets in the form of a UCC-1 financial statement and a security agreement. If the assets are secured in this manner, then as part of the sale, the seller will have to pay off the loan, or the buyer will have to assume the loan.
Statement of the business contracts that the buyer is assuming
A franchisee signs a myriad of contracts in order to operate the business. In each case, the buyer will be required to assume each such contract. The assumption of other contracts that aren’t integral to the franchise -- a contract to supply music for instance -- will be negotiated between the parties.
A statement concerning any real estate leases
The contract will also disclose how a real estate lease is to be handled. If the lease doesn’t contain the assumption language that’s otherwise required by the franchise agreement (see preceding item), then the buyer will have to negotiate with the landlord to take over the lease.
The “bill of sale” covenant
Assets are transferred by a bill of sale. This covenant identifies that requirement and then affirms that the exact bill of sale to be used is attached as an exhibit.
The agreement will state the price and the terms of payment -- which is usually the requirement that the price be paid (subject to adjustments) on the date of closing.
The covenant concerning the price usually includes the requirement that the buyer pay the seller a percentage of the purchase price at the time the agreement is signed as a good faith gesture of the buyer’s serious (“earnest”) intent to close the deal.
While the goal is always to have the entire purchase price paid at the time of closing, it’s often the case that the buyer won’t have all the funds to do so, in which case the franchisee will agree to “carryback” the balance in the form of a promissory note.
It’s usual for the franchisee/seller to have prepaid for certain expenses related to the operation of the business -- utilities and rent, for example. The prepaid expense often covers a period of time that straddles the closing of the purchase. In that case, the price will be adjusted to account for period of time the seller used the service before the closing and buyer used the service after the closing.
In virtually all cases, the franchisee/seller will have purchased inventory that will be used both before and after the closing. In that case, the parties usually agree to take an inventory count the day before the closing and then agree that the buyer will increase the price by the seller’s cost (but not cost plus profit) for all useable inventory.
The seller and buyer in the asset-sale transaction must report the matter to the IRS and to the state. Under tax law, one asset may be taxed differently than another. As a result, the allocation is negotiated and that is then reduced to writing.
Conditions or contingencies to buyer’s obligation to close
In addition to any other conditions previously called out in the asset purchase agreement, there will usually be a covenant that recites additional conditions that must be satisfied prior to buyer being obligated to close.
Seller’s representations and warranties
These are statements made in the contract by the seller in order to assure the buyer of his or her ability to close the deal.
Buyer’s representations and warranties
These are statements made in the contract by the buyer in order to assure the seller of his or her ability to sell the franchise and close the deal.
The asset purchase agreement will often include statements to the effect that the seller will continue to operate the business in its usual and normal course as though the asset purchase agreement was not signed. In this way, the buyer can be assured of getting the opportunity to take over a business that is generating money in the same way that it was before the sale was even contemplated.
All asset purchase agreements will contain indemnification covenants. Indemnification means that the buyer and seller will reimburse the other for any losses suffered as a result of some negligent act or wrongdoing of the buyer or seller relating to the terms of the asset purchase agreement.
Covenant concerning the closing
This will call out the date, time, and place of the closing and will reiterate each party’s obligations at the time of closing.
The buyer and seller will agree upon the rights that each has in the event that the other party breaches the contract before closing.
Any additional provisions not already found in the asset purchase agreement will be included here.