Franchise M&A | 3 High-Level Considerations

Franchise businesses have increasingly become a focus of M&A activity. This is in part due to greater interest and investment from private equity.

The franchise business model is by its nature unique.

Understanding its framework – and its moving parts – is paramount when engaging in any franchise M&A transaction.  

In this inaugural post of the series, we address 3 high-level considerations to bear in mind for a franchise M&A deal.

1. Strategic Objectives

There are typically four types of buyers for franchise systems: (i) entrepreneurs or existing franchisors, (ii) strategic ‘distribution network’ buyers looking to acquire a distribution channel for existing products, (iii) strategic ‘competitor’ buyers seeking to obtain additional market share, and (iv) financial buyers acquiring the business for future returns. There may be overlap, but each of these buyers has their own distinct motivations resulting in different strategic considerations. The relevant strategic objectives must be considered against the target system and its underlying assets. For example, take a system’s franchise agreements. Entrepreneurs and strategic ‘distribution network’ buyers, on one hand, should review the franchisor’s rights and obligations under the franchise agreements to ensure that there is room for the introduction of new products or services within the system. On the other hand, strategic ‘competitor’ buyers should review the franchise agreements to ensure that they do not contain any restrictions on or obstacles to owning or supporting competing brands.

Trend Insights: Interest and investment from both strategic and financial buyers has significantly increased over the past decade and, consequently, multiples for franchise systems are currently on the high end. This trend is set to continue, particularly as more private equity firms discover the allure of the above-mentioned investment features of franchise systems. 

2. Franchise Provisions

Knowledge and experience with respect to both franchise laws, as well as the franchise business model, assists with more robust negotiation and drafting of purchase agreements in the franchise M&A context. Such expertise will assist in crafting seemingly innocuous terms such as franchise-specific definitions as well as more significant terms like representations and warranties. The definition of “franchise agreement” in a purchase agreement should be carefully drafted to ensure that it captures all relevant variations of the franchise system’s arrangements. The definition may need to include joint venture, partnership, and other alternative licensing arrangements in addition to the typical structures like master franchising, area development, and area representation arrangements. Representations and warranties should also address franchise-specific matters and, in particular, the franchise-specific due diligence considerations. This may require provisions that address specific materials and documents, regulatory compliance, obligations of franchisors under the franchise agreements (including administration and operation of advertising funds), and communications with the franchisee population. Due diligence deficiencies may also require provisions providing for specific indemnities, covenants to remedy, holdbacks or escrows, or other mechanisms.

Trend Insights: Financial buyers are increasingly interested in various forms of investment, eg minority positions, acquiring master franchise rights for a particular jurisdiction, and in some cases joint venture arrangements. This necessitates careful structuring and negotiating of terms around the existing franchise arrangements (across jurisdictions).

3. Franchisee Community

Given that the franchisee population is at the core of a franchise system, it is ironic that a potential buyer’s access to franchisees (eg, to conduct due diligence) is often contentious and limited. Ultimately, the decision of when to inform franchisees of a transaction, and when to allow the buyer access to franchisees (as well as the extent of such access), depends on factors like the size and condition of the franchise, the relative bargaining power of the parties, and the due diligence protocols adopted by the buyer. A financial buyer (eg, a private equity firm) might be given greater access for due diligence purposes whereas a strategic buyer (eg, a direct competitor) may be provided more limited access. There is typically no statutory obligation to disclose a proposed transaction to existing franchisees. However, franchise disclosure laws may require that the proposed transaction be disclosed to prospective franchisees by means of the franchise disclosure document if it rises to the level of a ‘material fact.’ Beyond the question of timing, the tone and content of the approach and communications with franchisees is crucial. Franchisees may have a number of questions or concerns that buyers may wish to pre-emptively address.

Trend Insights: Some buyers choose to make the first announcement to existing franchisees (about their acquisition) moments before or post-closing. At that time, they will make a strategic presentation setting out the buyer’s background, expertise and experience, and the plans for the system going forward, with a view to obtaining buy-in from franchisees. In those circumstances, prior due diligence on these critical relationships is undertaken by third party implemented surveys with a sampling of franchisees (on an anonymous basis).

To receive further information or resources on franchise-related mergers and acquisitions, please email me. Stay tuned for our next post in the Franchise Mergers & Acquisitions series.

This post is published to inform clients and contacts of important developments in the field of franchise and distribution law. The content is informational only and does not constitute legal or professional advice. We encourage you to consult a McMillan franchise lawyer if you have specific questions or concerns relating to any of the topics covered here.