Asset Purchase Transaction for a Franchise

Buying and selling a franchise is rarely, if ever, a simply task - as there are all too often a multitude of complexities, hurdles and pressures bearing down upon the parties involved.

Contact Neufeld Legal PC for franchising legal matters at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

The purchase and sale of a franchise most often is undertaken by way of a share purchase transaction or an asset purchase transaction. An asset purchase involves buying specific assets of the business (like equipment, inventory, and the franchise agreement itself), rather than the corporation as a whole. This is a common method for acquiring a franchise resale and has distinct advantages and disadvantages.

Advantages of an Asset Purchase for a Franchisee

• Avoids Unknown Liabilities: This is often the most significant advantage. In an asset purchase, you are only buying the assets you explicitly agree to purchase in the contract. This means you generally don't inherit the seller's past liabilities, such as unpaid taxes, debts, lawsuits, or employee-related obligations from before the sale. This gives you a cleaner slate and significantly reduces your risk.

• Tax Benefits for the Buyer: An asset purchase can offer tax advantages. You can allocate a portion of the purchase price to the various assets you've acquired. This allows you to "step up" the basis of the assets and claim Capital Cost Allowance (CCA) (depreciation) on them over time, which can reduce your taxable income. For example, the value assigned to goodwill can be amortized over 15 years, and other assets like equipment can be depreciated according to their respective CCA classes.

• Control Over Employees: In an asset purchase, the seller is typically responsible for terminating all existing employees and for any related costs, such as severance and vacation pay. As the buyer, you can then decide which employees you want to rehire under new employment contracts. This gives you the flexibility to build your own team and avoid assuming any existing employee liabilities or disputes.

• Cherry-Picking Assets: You have the ability to select which assets you want to acquire and, just as importantly, which ones you don't. This allows you to tailor the purchase to your specific needs and avoid taking on any undesirable or unnecessary assets.

Disadvantages of an Asset Purchase for a Franchisee

• Complexity and Time-Consuming: An asset purchase is generally a more complex and time-consuming process than a share purchase. Since you are transferring individual assets, you may need to prepare separate legal documents for each category of asset (e.g., bills of sale for equipment, assignments of intellectual property).

• Need to Renegotiate Contracts: A major hurdle is that key contracts, such as the lease for the franchise location and supplier agreements, are not automatically transferred. You will need to renegotiate or seek the consent of the landlord, franchisor, and suppliers to assign these contracts to your new business entity. This can lead to delays and potential changes in terms.

• Potential for Disruption: Because you are not automatically taking over the existing business structure, there can be a disruption in continuity. Employees are terminated and rehired, which may cause a temporary lapse in operations.

• Higher Transaction Costs: The increased complexity of an asset purchase can lead to higher legal and accounting fees. Your advisors will need to spend more time on due diligence to ensure you are not missing any critical assets or inadvertently assuming liabilities, and on drafting and executing the numerous transfer documents.

Important Considerations Specific to Canadian Franchise Law

• Franchise Disclosure Laws: In "disclosure provinces" like Ontario, Alberta, Manitoba, New Brunswick, Prince Edward Island, and most recently, Saskatchewan, franchisors have a legal obligation to provide prospective franchisees with a comprehensive disclosure document (FDD) at least 14 days before any agreements are signed or payments are made. This also applies to the resale of a franchise. The franchisor's involvement in the transfer process means they must ensure the new franchisee receives proper disclosure.

• Franchisor's Approval: Regardless of whether it's an asset or share purchase, most franchise agreements require the franchisor's explicit approval for any change in ownership. The franchisor will assess the new buyer to ensure they meet their criteria and are a good fit for the system.

• GST/HST Election: In an asset purchase of a business in Canada, if you acquire "all or substantially all" (at least 90%) of the property necessary to carry on the business, you and the vendor can jointly elect to have no GST/HST payable on the sale by filing Form GST44. This can be a significant advantage, but it has specific conditions and does not apply to certain types of property or services.

It is critical to understand that the decision to proceed with a share purchase transaction or an asset purchase transaction is highly complex and depends on a variety of factors, including the specific franchise, the financial health of the business, the priorities of both the buyer and the seller, and their respective risk tolerances. It is absolutely critical to consult with a lawyer and an accountant with experience in franchises and business acquisitions and divestitures before making a decision.

Christopher Neufeld is a business lawyer knowledgeable in the rigors and challenges of the franchise business, together with the legal constructs that are critical to their effective operation. For experienced legal representation in starting, acquiring / selling, operating and managing a franchise, contact franchisee lawyer Christopher Neufeld at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or Chris@NeufeldLegal.com.

 

Contact us via email at chris@neufeldlegal.com or call 403-400-4092 / 905-616-8864.