ACQUIRING an INTEREST in an EXISTING 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

Acquiring shares in a corporation that is a franchisee involves a complex set of legal requirements and challenges that differ from purchasing an independently-owned business. The key distinction is the existence of the Franchise Agreement and the regulatory oversight of franchising law, in addition to standard corporate and securities laws.

A. Requirements Related to the Franchise Agreement

The Franchise Agreement is a contract between the franchisor (the brand owner) and the franchisee (the corporation you are buying shares in), and it dictates the terms of ownership transfer.

Franchisor Approval is Mandatory

• Consent to Transfer: Most Franchise Agreements contain strict provisions requiring the franchisor's explicit, prior written approval for any change in control or ownership, including the transfer of corporate shares, even if it's an internal transfer of a minority stake [more on franchisor requirement new shareholder / partner].

• New Owner Vetting: The franchisor will typically vet the prospective buyer (the share purchaser) to ensure they meet the franchisor's current standards for new franchisees, including financial stability, business experience, and personal background checks.

• Transfer Fees and Costs: The franchisor often charges a transfer fee to cover their administrative, legal, and training costs associated with the ownership change.

• Training and Certification: The new owner (or key management) may be required to complete the franchisor's current training and certification programs, even if the original owner was already trained.

• New Agreement: The franchisor may require the existing Franchise Agreement to be terminated and a new Franchise Agreement to be signed with the purchasing entity. This new agreement may contain terms and fees that are less favorable than the previous one.

Due Diligence on the Franchise Relationship

The buyer must conduct extensive due diligence not only on the franchisee's financials but also on the status of the relationship with the franchisor:

• Franchise Agreement Review: Scrutinize the Franchise Agreement for renewal rights, territorial restrictions, royalty payment history, and transfer clauses.

• Compliance Audit: Determine if the current franchisee corporation is in full compliance with the operational and contractual obligations of the Franchise Agreement. Any existing breaches could give the franchisor grounds to deny the transfer or terminate the agreement after the sale.

• Franchise Disclosure Document (FDD): Review the franchisor's FDD, which provides vital information on the system's history, litigation, fees, and obligations.

B. General Legal and Corporate Requirements

Since you are acquiring shares, you are buying the entire corporate entity, which brings distinct legal implications.

Inheritance of Liabilities

• Corporate Entity Remains: In a share purchase, the corporation (the franchisee) remains the same legal entity. You are simply replacing the former shareholders.

• Assumption of All Liabilities: You inherit all of the corporation's past, present, and unknown future liabilities, including outstanding debts, tax liabilities, legal claims, employee issues, and environmental risks, even those that pre-date your purchase.

• Indemnities and Representations: You'll require robust representations, warranties, and indemnities from the seller in the Share Purchase Agreement to protect you from undisclosed past liabilities.

Securities Law Compliance

• Private Transaction: Since you are likely buying shares in a privately held corporation, the transaction must comply with applicable federal and provincial securities laws.

• Prospectus Exemptions: The sale of shares must usually fit within a prescribed prospectus or registration exemption (e.g., a private placement exemption) to be legal. This typically involves the purchaser being an "accredited investor" or meeting other legal criteria to ensure they can sustain the risk of the investment.

C. Key Challenges

Risk of Veto

• The single biggest challenge is that the franchisor can veto the entire share transfer transaction, rendering your deal with the seller worthless, even if you have a signed Share Purchase Agreement. The deal is fully contingent on franchisor approval.

Tax and Valuation Complexities

• No "Step-Up" in Asset Value: Unlike an asset purchase, a share purchase generally does not allow you to "step up" the tax cost base of the underlying assets to the purchase price. This can reduce future tax deductions (like depreciation) for the corporation.

• Valuation Difficulty: The valuation must account for the ongoing royalty and advertising fees paid to the franchisor, the term remaining on the Franchise Agreement, and the overall brand strength, which are all factors outside the franchisee's direct control.

Maintaining Confidentiality

• Franchisor Information: The franchisor's operational manuals, recipes, or proprietary information are highly confidential. As the new shareholder, you must ensure continued compliance with all confidentiality and non-disclosure clauses in the Franchise Agreement.

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.