The impact of existing lease and franchise agreements on the valuation of a business
In this article we will attempt to illustrate the impact that existing lease and franchise agreements may have on the purchase transaction. Please bear in mind that this is not intended to be an exhaustive list and that it is always advisable for the purchaser of a franchised business to seek professional advice regarding the terms of existing agreements, and their possible impact on the future of the business.
By Kobus Oosthuizen
Buying an existing business implies buying the assets, both tangible and intangible, in order to continue trading for the purchaser’s gain. However, there are two “assets” that do not form part of the assets of the business, but where an agreement exists between the seller of the business and the owner of such assets for the use thereof, and where the seller of the business would be required to cede or sell his rights thereto to the purchaser.
- The business system
In the case of a franchise business, the intellectual property applied within the business does not belong to the seller, but to the franchisor. The right of the franchisee to use the intellectual property (trademark and know-how) of the franchisor is confirmed in the franchise agreement that exists between the two parties. In terms of such an agreement the franchisee acquires the right to use the business system in exchange for royalty payments.
Franchise agreements should be restrictive regarding the transfer of rights, such as use of the franchisor’s intellectual property, granted to the franchisee. A key consideration for the franchisor is whether the purchaser is suitable and qualified to become a franchisee. For this reason it is imperative that any sale and purchase agreement incorporates a clause stating that approval of the buyer by the franchisor, through the franchisor’s normal application channels, is a condition of the sale, regardless of the buyer’s ability to pay for the business.
- The premises from where the business is operating
It is seldom that the business owner is also the owner of the building where the business is operating from, and even if that is the case, such a building may not be part of the sale object. The rights and obligations of both parties are described in the lease agreement and the terms of such an agreement will always supersede any of the terms of the purchase and sale agreement.
Lease agreements are less restrictive when it comes to the transfer of rights to occupy the premises, but the landlord will have to grant his consent to the transaction and this is likely to include some form of assessment of the buyer.
Sign new agreements
Generally both the landlord and the franchisor would be keen to enter into fresh agreements and it is advisable that the purchaser pursues this option. The purchaser must however endeavour to ensure that the rights and obligations of the business are not negatively affected. On the contrary, based on the financial position of the new franchisee (tenant) the landlord may even be prepared to offer more generous terms as well as the fact that the duration of the new lease agreement will be longer than the remaining period of the current agreement.
If new agreements are not signed, and existing agreements are ceded instead, ensure that the remaining term and the right to renew such agreements are not affected by virtue of the purchase and sale transaction. This should be done through written confirmation from the landlord and the franchisor.
The purchaser should scrutinize both the lease and franchise agreements for any obligations he will "inherit" that may impact on the valuation of the business. An example of this would be the franchisee’s obligation to refurbish the business. Depending on when such refurbishment has to be completed, a downward adjustment of the purchase price should be considered.
Ascertaining that the expenses and terms provided for in the current income statement correlates with the terms of the franchise and lease agreements, should form part of your investigation to confirm the profitability of the business. Any amounts owed to either the landlord or the franchisor must be declared and provided for in the disbursement of the proceeds of the sale.
Kobus Oosthuizen
SA Franchise Warehouse
www.safw.co.za
By Kobus Oosthuizen
Buying an existing business implies buying the assets, both tangible and intangible, in order to continue trading for the purchaser’s gain. However, there are two “assets” that do not form part of the assets of the business, but where an agreement exists between the seller of the business and the owner of such assets for the use thereof, and where the seller of the business would be required to cede or sell his rights thereto to the purchaser.
- The business system
In the case of a franchise business, the intellectual property applied within the business does not belong to the seller, but to the franchisor. The right of the franchisee to use the intellectual property (trademark and know-how) of the franchisor is confirmed in the franchise agreement that exists between the two parties. In terms of such an agreement the franchisee acquires the right to use the business system in exchange for royalty payments.
Franchise agreements should be restrictive regarding the transfer of rights, such as use of the franchisor’s intellectual property, granted to the franchisee. A key consideration for the franchisor is whether the purchaser is suitable and qualified to become a franchisee. For this reason it is imperative that any sale and purchase agreement incorporates a clause stating that approval of the buyer by the franchisor, through the franchisor’s normal application channels, is a condition of the sale, regardless of the buyer’s ability to pay for the business.
- The premises from where the business is operating
It is seldom that the business owner is also the owner of the building where the business is operating from, and even if that is the case, such a building may not be part of the sale object. The rights and obligations of both parties are described in the lease agreement and the terms of such an agreement will always supersede any of the terms of the purchase and sale agreement.
Lease agreements are less restrictive when it comes to the transfer of rights to occupy the premises, but the landlord will have to grant his consent to the transaction and this is likely to include some form of assessment of the buyer.
Sign new agreements
Generally both the landlord and the franchisor would be keen to enter into fresh agreements and it is advisable that the purchaser pursues this option. The purchaser must however endeavour to ensure that the rights and obligations of the business are not negatively affected. On the contrary, based on the financial position of the new franchisee (tenant) the landlord may even be prepared to offer more generous terms as well as the fact that the duration of the new lease agreement will be longer than the remaining period of the current agreement.
If new agreements are not signed, and existing agreements are ceded instead, ensure that the remaining term and the right to renew such agreements are not affected by virtue of the purchase and sale transaction. This should be done through written confirmation from the landlord and the franchisor.
The purchaser should scrutinize both the lease and franchise agreements for any obligations he will "inherit" that may impact on the valuation of the business. An example of this would be the franchisee’s obligation to refurbish the business. Depending on when such refurbishment has to be completed, a downward adjustment of the purchase price should be considered.
Ascertaining that the expenses and terms provided for in the current income statement correlates with the terms of the franchise and lease agreements, should form part of your investigation to confirm the profitability of the business. Any amounts owed to either the landlord or the franchisor must be declared and provided for in the disbursement of the proceeds of the sale.
Kobus Oosthuizen
SA Franchise Warehouse
www.safw.co.za
Preserving cash when beginning a new business is important, so people should be make their own franchise agreement from an example in PDF structure. This content describe about franchise agreements very perfectly, nice to read it.
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