Franchise Mergers and Acquisitions
Mergers and acquisitions are common in the business of franchising – whether acompany is acquiring another franchise or being acquired itself. This article describes some of the reasons that companies would be interested in acquiring franchise opportunities or in being acquired, as well as some tips for what companies should look for when they're interested in buying or being bought. Lastly, we'll address a number of factors that should be considered before any franchise merger or acquisition transaction is completed.
There are certain steps a franchisor can take ahead of time if the brand is looking to be acquired by another company. First, the franchise will want to make itself seem as valuable as possible to potential buyers. Classic signs of a juicy acquisition target include having an experienced management team that's not overly dependent on one person, having consistent revenue and profit growth, reducing revenue concentration risk by avoiding reliance on too small a number of clients or customers, having strong products and services that lead their respective industry, and erecting high barriers to entry for competitors.
It is recommended that a franchisor looking to exit its business and be acquired outline a strategy up to three years in advance, giving the franchise time to implement any changes necessary to make the business more attractive to prospective buyers. A franchisor can hire a public relations firm to get positive media coverage of its business. It can make sure all intellectual property of the franchise is protected by trademarks and patents, and consider registering the property in other countries if international expansion is a possibility. The franchisor can make sure the financial side of its business is well ordered and transparent, and can put together a solid management team, enticing management to commit to remaining with the company after the sale by properly structuring their employment contracts.
While the franchise has control over these steps, there may be macroeconomic changes that are out of the franchisor’s hands, such as recessions, industry changes, or major geopolitical events. However, putting the franchise in a strong position will help to weather these events as well as possible. Franchisors looking to be bought should contact an investment banker early in the process to plot out a strategy.
Acquiring A Franchise
There are several reasons for franchises to consider acquiring another franchise. It could give them the opportunity to add new products without the risk or cost of developing these offerings internally. It could help the buyer add new markets, geographically or demographically speaking, with an already strong existing brand. Acquiring a franchise supplier or distributor could build efficiency through vertical integration. Acquisitions can also help a franchise develop sufficient scale to compete with a larger rival more effectively.
A franchisor looking to merge with or acquire another company first has to find a target. Some qualities that a franchisor should look for in a potential target include (1) those companies operating in industries with growth potential, (2) companies with ironclad franchise agreements with their franchisees, (3) companies which are not tangled in complex litigation, (4) companies with high levels of customer satisfaction and brand loyalty, (5) companies with protected proprietary products and services and (6) companies already interested in selling.
Once a franchisor thinks it has found a target, it should analyze a number of factors regarding that franchise. The acquiring company should break down the strength of the target’s trademarks, the quality of the target’s sales staff, the quality of the target’s training and operations manuals and other support systems, the performance of company-owned units (if any) and the strength of the relationship between franchisor and franchisees.
If the franchisor decides it wants to proceed with the acquisition, there are a number of questions its legal and financial representatives will want answered during the due diligence phase, thereby making sure the acquisition is both smart and legal.
The lawyers will consider potential legal impacts, including whose approval is necessary to complete the transaction, if there are any anti-trust issues that will arise, what the tax consequences of the acquisition are, what securities laws and regulations apply, whether there are any limitations on transferring assets, if state or federal labor laws have any bearing and whether employment, confidentiality and non-compete clauses should be created or modified.
Business advisers will be interested in a whole different set of questions, related to the financials of the target, and the outlook for the future of the target’s business, as well as how well the target fits within the acquiring company. Additionally, the financial team will want to know how the target fits in the acquiring company’s long-term plans, and how the acquiring company plans to use and deploy the target’s resources. They will want to consider how competitive the target’s products or services are in the market, and who manufactures them (if products). They will also want to know what the sales history of the target is, what the ratio is between company-owned outlets and franchisees, and whether there's any history of excessive franchisee failures or terminations, and for what reasons.
There are a couple of common mistakes made by the franchisors in the due diligence period that any franchisor should be sure to avoid. First, there should be compatibility between the buyer’s review team and the seller’s documents – if the documents are technical, the buyer needs to make sure it has people capable of understanding them. Next, the acquiring company should make sure an appropriate amount of time has been devoted to financial and tax matters, and that examinations of these matters have been thorough. The franchisor should use the opportunity to make sure that even aside from the financials, the two companies are a good fit from a cultural and vision perspective. The buyer should also make sure that its team is warmly received by the seller – good communication and relations between the companies will make for a speedier and more effective integration.
In either of these scenarios, it is important to remember that the franchisees have a stake in the business as well. The franchisor should have potential franchisee concerns in mind through the acquisition process. Although there may be no legal obligation to inform franchisees of potential mergers and acquisitions activity or need to get their approval before the transaction is complete, it is good policy to keep them at least somewhat in the loop; strong franchisee relations and good communication are both key elements for any successful franchise over the long term. Specific areas of potential franchisee concern that should be considered include what the future plans are for the franchise after the acquisition, whether the acquiring franchisor will be sensitive to the needs of the target's franchisees, how the acquisition will affect property leases and third party vendor relationships, and whether the financial position of the acquiring franchise will lend itself to new product lines, growth and expansion, or increased advertising.
Ultimately, the decision to enter into any form of mergers and acquisitions activity should be weighed with utmost care and consideration, as a deal can be one of the most transformational events in the entire history of a franchise system.
Determining Your Priorities
At its core the decision to open a franchise isn’t a trivial decision. You are making a serious investment, but if you take all of the factors into account it can be an amazing one. But before you get there you need to sit down, analyze your needs, capabilities and limitations in relation to a franchise business. This could take a few days to consider or a few weeks or months. In either case, it is one of the most important steps in the franchising process, so don’t skip it.
Watch out, Franchisees! 10 Franchisor Red Flags
Only a limited number of states require registration by franchisors, and franchisors are by no means required to register in states where they have no intention of selling franchises. However, if a mature franchisor appears to be consciously avoiding the registration states, this may suggest some level of internal concern about the FDD, the franchisor’s sales tactics, or the franchise system as a whole. The cover pages of the FDD will identify where the franchisor is required to register (and whether it has registered or not), and the charts in Item 20 of the FDD will explain whether the franchisor has ever sold a franchise in any of the registration states.
Financing the Acquisition
Financing the acquisition of a franchise is not a slight affair, as with the legal fees, the initial fee, allocation for resource acquisition and various other expenses the cost raises significantly. Therefore financing often becomes mandatory in that situation. Mostly people concentrate on third party financing where they seek out investors and other debt or equity lenders for their financial needs. However, two of the most overlooked options are: