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I Want to Buy an Existing Franchise Business—What are the main legal issues?

Buying an existing business has a lot of risks and pitfalls in and of itself, but buying a franchise business brings with it a whole host of additional issues the unsuspecting buyer must take into consideration.

Once you have an agreement on the basic terms (price, what you are buying, what are you not buying), you need to have an appropriate Asset Purchase Agreement drafted, which is the most critical part for the buyer, in that this agreement must give you a lot of contingencies to back out, plus the protections against things coming up after the sale if you go forward. Utilizing an experienced business attorney is important; Utilizing an experienced franchise attorney is critical. Why? Because there are numerous conditions the Franchisor is going to require in order to approve your Seller's ability to transfer the franchise location. An experienced franchise attorney, such as myself, will make sure you that you have your own contingencies to back out, in the event the Franchisor's contingencies are too burdensome.

For example, with any business you'll need to conduct the due diligence in reviewing the condition of furniture fixtures, equipment, signs, décor, computer systems, contracts, employees, and liabilities and obligations of the business you will and will not be buying. If the business has specific equipment, which is expensive to replace, it goes without saying that you should have a professional do the equipment inspections, including how often these specific types of equipment break down, and related maintenance expenses. When you are buying a franchised business, the Franchisor has a right to require the premises to be remodeled or upgraded including any furniture fixtures, equipment, signs, décor, computer systems and supplies. This can be a significant expense, which the Buyer may want you to assume. Your Asset Purchase Agreement must have a contingency to give you an out if you do not like or want the remodel/upgrade requirements mandated by the Franchisor.

Another similarly important due diligence item is analyzing the financial statements. It is not enough that you just review them and like what you see; your Asset Purchase Agreement must contain a Seller warranty and representation as to the accuracy of those statements, which gives you protection and a right to go back to the Seller in case the financial statements are inaccurate. More importantly however, is that the amounts the Seller is paying to the Franchisor will be based on the Seller's Franchise Agreement, which is likely many versions older than the Franchise Agreement you will be required to sign. It is critical you determine what are the newer and additional financial franchise obligations in the new franchise agreement YOU WILL BE SIGNING, which will completely change the financial picture and net income. Thus, your Asset Purchase Agreement must contain a contingency that you agree and approve of the new franchise agreement terms (you'll definitely want a franchise attorney to review this), and the right to review the Seller's franchise agreement just to compare.

The 3rd important piece is the lease. Your Asset Purchase Agreement will need a contingency that you must approve of the lease terms you will be assuming, or any additional lease requirements the Landlord may require. (This is also an opportunity to re-negotiate the lease terms more to your benefit). You do not want to skip the step of having a business attorney review the lease even if you cannot re-negotiate, you still need to understand the red flags and most concerning provisions-even a great business can be sabotaged by bad lease terms. (Perhaps that is why the Seller is selling).

These are only a few critical items. There are many more, such as having the Franchise Disclosure Document or FDD reviewed, requiring a Seller non-competition clause, requiring certain level of inventory at closing, requiring Seller terminate all employees at closing, and much more. As an experienced franchise attorney, my goal is to protect the buyer in all areas as much as possible in all 3 pieces of buying an existing franchised business (The Asset Purchase Agreement; the new franchise agreement, and the lease.)

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