Presentation on theme: "What do you need to know about capital raises and transactions in franchising?"— Presentation transcript:
What do you need to know about capital raises and transactions in franchising?
DLA PIPER LLP (US)2 Preparing for Sale or Capital Infusion Determine if underlying rationale and premises for purchasing company or assets/providing financing is correct More accurately value target (including any purchase price adjustment) and verify business model for the target Uncover problems that should be solved or ameliorated prior to closing Gather an understanding of benefits and risk associated with acquisition/loan Verify representations and warranties in purchase/loan documents Determine representations, warranties and indemnities that should be negotiated into the purchase/loan documents based on issues discovered in due diligence Purpose of Due Diligence Phase?
DLA PIPER LLP (US)3 Franchise Due Diligence – What areas of inquiry will be evaluated? Solid unit-level economics for franchised and company-owned units (can franchisee make a profit?) Proven Business Model (in multiple markets) Impediments to future growth (territories, supply chain available) Prospects for future growth and expandability of the system (pipeline, development commitments) Ability to bring franchise system under a portfolio entity that owns multiple businesses Franchisee Satisfaction (Franchisee surveys, Franchisee interviews, renewal history, continued development by existing franchisees) Threatened Litigation, Pending Litigation and Regulatory Action Regulatory Compliance with focus on franchise regulations (franchise registration laws, franchise relationship laws, FDD compliance) Franchise Sales Process and Procedures (experience, internal controls, training) Franchise Agreement provisions related to enforcement (history of updates/changes to Franchise Agreement) History of enforcement or lack of enforcement of provisions in the Franchise Agreement (custom/practice, waiver) Transferability of Franchise Agreements and other contracts Remaining terms of current franchise agreement Comfort Letters (What has been promised? Are letters maintained?)
DLA PIPER LLP (US)4 Franchise Due Diligence – What areas of inquiry will be evaluated? Real estate documents (collateral assignment of leases, leases, lease guarantees) Development Agreements (compliance with development schedules) Ownership, protection and licensing of intellectual property (trademarks, patents, copyrights, domain names) Condition of Manuals and System Standards Advertising Fund (records related to use of fund, loans to fund) Employment agreements with management and confidentiality agreements with employees Franchisee history of non-payment or other non-compliance Current defaults and disputes in franchise system Franchisee Association and Advisory Councils files and minutes (window into system – franchisee relations, problems with business model, promises) Reports on supplier rebates, commissions or other payments Gift card program System wide communication Current Franchisee files and files for franchisees that have left the franchise system Executive interviews (to learn about the system and ascertain strength of management team)
Steps Sellers or Borrowers Can Take to Prepare for Transaction
DLA PIPER LLP (US)6 Steps Sellers or Borrowers Can Take to Prepare for Transaction Long term Make decisions on franchise agreement considering potential purchasers (decisions that limit a franchisors options long into the future could impact price and/or pool of potential purchasers) Obtain guarantees, confidentiality agreements and non-competition agreements from owners (properly executed by individual/entity, do not include as exhibit if not in use) Prepare franchise files to demonstrate compliance with laws (logs of required procedures, documents and critical dates) Ensure Trade Secrets are secure (confidentiality and non-competition agreements are in place, trade secret audit, work for hire agreements employees/vendors) Trademark and Patent Software licenses to operate franchise system Document long-term arrangements with critical suppliers and vendors Limit negotiated changes and special deals in Franchise Agreements Keep track of negotiated changes (addendum or redlined in Franchise Agreement) Have form documents (transfers, releases, default letters, comfort letters)
DLA PIPER LLP (US)7 Steps Sellers or Borrowers Can Take to Prepare for Transaction Short term Organize and Retrieve Documents and Files (FDDs/UFOCs for multiple years, financial performance/earnings claim documentation, franchise registration certificates) Audit Franchisee Files (e.g. properly executed Franchise Agreements, FDD/UFOC receipts, insurance certificates, real estate documents) for presence in file and proper execution Obtain any missing Franchise Agreements and renew any expired Franchise Agreements Document any undocumented transfers Prepare employees that are critical for process (will be wearing multiple hats during sale phase) Find ways to explain and describe state of franchisee relations Focus on resolving franchisee compliance issues (late payment issues, non- compliance with computer system requirements, ACH-Payment issues, poor performance, non-compliance with development schedules, under reporting) Terminate Franchise Agreements for closed units or undeveloped units Trademark infringements
DLA PIPER LLP (US)8 How will preparation for Transaction benefit the seller or borrower? Maximizes value of franchise system and could reduce justification for earn outs and hold backs Smoothes process Builds credibility and trust Shortens due diligence phase and increases the chances of closing Reduces the justification for overreaching representations, warranties and indemnities Gives purchaser/lender a good impression of management team Reduces management resources necessary to respond to questions from purchaser or lender during due diligence phase Reduces legal costs (for seller/borrower and purchaser/lender) Makes seller/borrower aware of weaknesses prior to commencing process Provides seller/borrower with an opportunity to prepare explanations for problematic issues (litigation, files, franchisee relations)
DLA PIPER LLP (US)9 Now What to Do When Purchasers Raise Legal Issues? Provide enhanced benefits to the purchasers in the terms of the purchase/merger agreement Enhanced representations and warranties Lengthen the survival period for the representations and warranties Reduce the deductible under the indemnification provision Escrow part of the purchase price Offer to remedy the problems prior to executing the purchase/merger agreement Obtain releases from franchisees Offer a stated period during which the seller cleans-up the problems Permit the purchaser to conduct survey of franchisees (anonymous) Obtain clearance letters from state regulators Settle franchisee disputes or litigation
DLA PIPER LLP (US)10 Now What to Do When Purchasers Raise Legal Issues? Reduce the purchase price or make a portion of the purchase price part of an earnout Purchaser pays a set amount for each completed franchise agreement Purchaser pays a set amount for each release obtained from a franchisee Offer rescission to affected franchisees thus making franchise system less of a risk to the purchaser Convince purchaser that problems/issues are not significant or do not adversely affect the value of the business being purchased Who has the leverage? Is the transaction part of an auction process? Statute of limitations? Offer to pay legal fees and costs for clean-up