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Private Equity − Making the Deal

Following best practices and keeping accurate records can pay huge dividends when looking to conclude a private-equity transaction.

Although there are those who want to leave the largest legacy to future generations, most franchisors are openly working toward one or more liquidity events, where they can raise outside investments to fund growth, “take some chips off the table” or exit entirely. Sometimes, successful franchisors have the greatest need for a vehicle to finance their growth.  The more units cost, the longer they take to open and the more reliant on outside brokers, the more immediate the franchisor’s need for outside financing.

Over the past several years, private equity has filled the gap created by the contraction in the commercial lending market.   As commercial lenders have embraced more onerous qualification criteria, private equity has become increasingly interested in franchising and moved large pools of private money into the franchise arena.   Moreover, the use of equity rather than debt can improve the franchisor’s balance sheet.

Private equity has expanded its reach beyond franchisors, to large franchisees and suppliers of franchisees, with the potential to scale their respective business models.   The scalability of strong business models is the primary attraction of franchising to private equity. Traditionally thought to be relegated to only large transactions, private equity is appearing in smaller transactions at the lower end of the market. Private funds have demonstrated amazing speed and dexterity in performing due diligence and concluding transactions.

While there is lot of private-equity money floating around, the more reputable funds are comprised of investments of retirement and investment accounts from large, often blue chip, institutional investors.  These investors have their own investment strategies and desired holding periods before they want to realize a return.  There are countless examples of franchisors who engage in a series of successive investment transactions with private-equity firms, each with a different appetite for transaction size and risk, and each with its niche in the capital market.  Based on shorter-holding periods, franchisors need to know exactly how to deploy the money and precisely when they need to refinance it.

As an emerging brand, the last place you want to be is the one with a great opportunity without the ability to finance it.  This happens much more often than you might expect.  As a partner of a firm heavily engaged in due diligence projects for private-equity funds, I can think of multiple instances where a franchisor compromised a transaction or cost itself money at the closing table because its house was not in order.  Most of the circumstances we come across are avoidable, caused by “pilot error” and without the benefit of competent counsel or professional advice. The purpose of this article is to share some of the common recurring themes we come across in franchisor due diligence, so that you can design your emerging brand’s future with that goal in mind.

Private-equity firms have no universal measuring stick to evaluate opportunities, but most would agree that the highest and best earnings multiple and price would be attained by a company with:

  1. Strong unit-level economics;
  2. Ample opportunity for growth in new units, rebates and system-wide revenue;
  3. Strong franchisee relationships;
  4. Strong management with a vision of the future;
  5. Recurring revenue streams;
  6. A strong track record of performance; and
  7. Use of best practices in contracting and operations.
  8. Scope and Goal of Franchise Due Diligence

All franchisor due diligence starts with a list of requested documentation about the target franchisor.  Today, these materials are assembled in data rooms and inspected off site.

In the course of our franchise agreement review, we identify all forms of franchise contracts used by the franchisor and tie out literally every franchise which was ever granted to some disposition.  We look at every form of franchise disclosure document which is within any unexpired statute of limitations.

After carefully analyzing each offer and the changes to the offer over time, we carefully document negotiations from the standard form for each franchisee.  We prepare massive spreadsheets showing all the negotiations and compile them into a comprehensive report.

Next, we determine whether each sale was made in a manner which is regulatory compliant, and review receipts and all registration files where applicable. In the course of our review, we look for potentially “at-risk” revenue, those which are soft or have the potential to cease at a foreseeable point in time.  Revenues can be soft when a large proportion of open units are operating under expired contracts, or when franchisees have a unilateral right to terminate, or retain exclusives despite an exhausted development obligation, extensive rights of first refusal or a contractual right to purchase from third-party suppliers, or a monetary or time limit to implement future remodeling, upgrade or advertising obligations.  Revenues can also be at-risk because the franchisor has waived or failed to obtain any rights to the telephone numbers or real estate used in connection with the franchise business upon a termination of the franchise agreement.

We are also looking for contractual obligations to be contained in a modern form of agreement with a mechanism to upgrade to the new form of contract upon renewal or transfer, and well-drafted confidentiality, non-competition,  indemnification, dispute resolution, choice of law and venue, and waivers of rights to jury trial and consequential damages, to name a few.

All franchisor due diligence starts with a list of requested documentation about the target franchisor.

In addition to at-risk revenue, we also seek to quantify any exposure from a failure to comply with any applicable state statutes, including the likelihood of having sales suspended in a particular state during any investigation, and any foreseeable fines or penalties, statutory rescission rights and franchisee-initiated civil claims arising from any issues uncovered in the due diligence process.


In the course of our review, among the most important lessons learned for an emerging brand are:

Recordkeeping Lesson No.1 – Keep a complete file

The biggest failure we see is that franchisors do not keep complete records of transactions with franchisees and state regulators, and in some cases suppliers.  In every transaction, there are franchise agreements and other documentation which is unsigned, no copies of real estate leases and spotty execution of guarantees, collateral assignments of leases and telephone numbers which often are part of the FDD. Correspondence often resides on the laptop of the sender, and never makes it to the official file.  Contractually based notices, like default or termination notices, are not sent or retained, and franchisors routinely fail to document mutual terminations (after a unit closing) or obtain releases (when they have an opportunity).  Here, the solution lies in designating a particular person as the keeper of the file, and developing operating protocols and job descriptions that facilitate the transfer of relevant information between the right folks.

Be sure to enter into single-unit agreements every time a franchisee opens a unit or expands the territory.  Most single-unit agreements are written to accommodate the operation at a single unit, and things like non-competes, exclusive trading areas, quotas and contractual minimums typically need to be adjusted to accommodate multi-unit or territory operation.  Also, make sure to document each renewal, and don’t get into the habit of verbally renewing the existing form of agreement to avoid the claim that you waived your right to require the renewing franchisee to execute the then current form some time in the future.

Moreover, if you have critical suppliers that you count on to be successful or to assist in distribution, advertising, franchise sales or brokerage, real estate or construction, it is wise to document those relationships.  Especially when your point of differentiation is based on a secret recipe or the use of a proprietary product, there is an even more critical need to prevent access or disclosure to competitors.

Consequences of Negotiation

Everywhere but California (where franchisors must notify regulators  within 15 days of any negotiated sale, and thereafter provide notice of the negotiated term to California prospects for 12 months), franchisors are free to negotiate terms of the proposed contracts with franchisees privately.  Emerging franchisors often concede significant terms to single- and multi-unit franchisees in an effort to conclude deals, without realizing the implications for the future.

First, if you want to negotiate a particular term, the best practice is to return to the drafter to document the change in a separate form of amendment. Absent that opportunity, you are well served to think through the change and any other provisions implicated by the change, and then carefully document the parties’ intentions.  Be wary of granting unilateral rights to any franchisee to approve a supplier or block a transfer.

Finally, don’t grant rights in perpetuity. If you grant rights to a larger territory, make sure to include a development schedule or other time or performance measured milestone, where such rights revert back to the franchisor upon the franchisee’s failure to attain contractual minimums within the defined period of time.  Never leave a franchisee with a large exclusive territory without a development obligation.

Following best practices and keeping accurate records is entirely in a franchisor’s control and can pay huge dividends when looking to conclude a private-equity transaction.

Lane Fisher, CFE, is a partner of the full-service law firm Fisher Zucker LLC, which has offices in Philadelphia and Cherry Hill, N.J.  He can be reached at 215-825-3131 or


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