Transition planning considerations for franchise owners

(3 min read)

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Just like other successful business owners, franchise owners need to plan for the eventual transition of their franchise business. As with business owners, advance planning for this helps to maximize the transition value of the business, minimize future taxes, and secure preparation for both expected options and unexpected events such as the sudden disability or death of a franchisee.

With a franchise however, there are even more planning concerns to be aware of and matters that need to be taken into consideration. The business transition or estate planning undertaking is usually more complicated for a franchise business owner than for their business owner counterpart, due largely to the agreements in place between the franchisor and the franchisee.

What are the key franchise transition issues?

Key planning issues requiring consideration such as: options for transition, timing, tax exposure and contingency plans; all have additional complications based upon the nature of the franchise relationship.

Every transition decision a franchisee makes also affects the franchisor, who has a right to protect their business network. Therefore, all franchise agreements include substantial transition obligations.

In many situations, franchisees have not reviewed their franchise agreements since the inception of their business and are often unpleasantly surprised by some of the terms found in the agreement. Only with proper advance planning will a business transition be successful or an estate plan be effective.

Preliminary franchisee matters to consider:

A thorough review of the franchise agreement is required to ensure awareness of rights and responsibilities that need to be considered prior to formulating an estate or business transition plan. The following items may differ for each franchisee depending upon the nature of the franchise, however, each are important:

• Term and options for renewal are the fundamental rights needing to be transferred. The value of the franchise is often calculated based upon the length of term remaining and the requirements needing to be satisfied before the options for renewal can be transferred. Always be aware of when the term may be expiring. Often there are advance notice renewal requirements. If the time period is missed, then the franchisor may withhold its consent. The agreement will also have to be in good standing, which means all the operational terms and conditions will have to be satisfied.

• Additional costs and expenses are involved. The franchisee and the franchisor will have to expend time, pay for costs related to due diligence and retain legal counsel to address all the transition requirements. The additional franchisor expenses are often passed on either directly or indirectly in the form of a consent fee that is set out as a term of the agreement. The fee charged by the franchisor varies, however it can include a percentage of the original franchise fee or the transition sale price.

• Consent from the franchisor must be received before exercising options for transition including transitioning the business to employees or family members. In many cases, the franchisee must obtain advance consent to the transition. Franchises are granted based upon an overall business and financial evaluation of an applicant. This evaluation forms the basis for the original obligations required by the franchisor. Any management or ownership changes have an impact on the overall franchise relationship. This also applies to internal reorganizations that affect the status of the franchise, such as the transfer of shares to new holding corporations and family trusts. Most importantly, there is also a long list of consent conditions. These include financial, managerial, training and other operational conditions that need to be first reviewed and then approved by the franchisor.

• The franchise agreement demands must be aligned with the will and referenced within the will with regards to transfer of ownership; otherwise, the franchisee could be penalized under the franchise agreement to the unfortunate detriment of his or her estate. It is essential to ensure that any estate planning entered into does not conflict with the franchise agreement.

Additional rights of the franchisor

Irrespective of the plan for transition, the franchisor in certain circumstances has the right to take back the franchise. This could arise in situations where the franchisee has failed to obtain consent to the transition or is in default and the franchisor is taking steps to terminate the franchise.

Even if in good standing, the franchisor may have a right of first refusal. This is often triggered when the franchisee receives a bona fide offer to purchase from a third party which it wishes to accept. The franchisor may then exercise its option to purchase on the same terms that the third party was willing to pay. Often after deducting an additional fee for taking such steps!

Unintentional events that may trigger a transition

Unexpected events such as a sudden disability or death could be the cause of the untimely transition of the franchise. Most agreements set out these situations as terminable events that require the franchisee’s estate to complete a transfer within a limited period of time. This time obligation is often less than one year and puts considerable strain on the affected family.

It is very important to complete planning in advance with the franchisor and have either a formal successor addendum or a basic back-up plan in place. The most common back-up plan is designed to transfer ownership and management responsibilities to existing family members that are working in the business.

Notwithstanding their experience within the franchise, family members will still require additional training and have financial hurdles to be satisfied. These requirements are also associated with a probationary period to ensure that the new franchise is continuing to be operated in accordance with acceptable standards.

Management and ownership succession issues

Oftentimes the franchisee is very active in the business and oversees much of the day-to-day operations. It can be questionable whether the business can even function well without the franchisee for an extended period of time.

Without the transfer of capabilities and knowledge ahead of time, key relationships that contribute to the success of the franchise could be compromised with an unexpected managerial transition. It is important to minimize the interruption of any ongoing operations if something unforeseen were to happen to the franchisee.

Conclusion

Developing an estate and transition plan for a franchise can be a lot more complicated than for private owner-managed business. Key franchise transition planning steps:

1. Know your franchise rights and obligations;
2. Ensure you have the financial resources to pay all costs and expenses including potential estate taxes;
3. Put a team together that includes a transition planning specialist and a trusted financial, legal and tax advisors;
4. Work with your franchisor to ensure they are part of the process;
5. Establish key continuity steps, options and back up plans as part of the planning process; and

Start working on your plan today!

Nancy Ammari, CFA, CFP, is a Wealth Advisor for Scotia Wealth Management™  | ScotiaMcLeod^®, a division of Scotia Capital Inc.

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