By Cliff Ennico
“About 10 years ago, I bought a franchise that provides an essential service for building contractors. Because the franchise was new, I was able to cut a terrific deal for a large territory in my state. I’m paying only a flat royalty fee each month, not a percentage of my gross sales as is typical for most franchises, so my margins are very generous.
“I’ve worked my tail off to build the territory, and now I’m earning more than $1 million a year in gross sales.
“I’m planning to sell the franchise within the next year or two so I can retire, but I’ve hit a snag. The franchise has indicated that it will honor my ‘flat-fee’ royalty arrangement for the remaining term of my franchise agreement (five more years), but anybody who purchases the franchise will have to agree to pay a percentage of gross sales going forward. This will eat significantly into the buyer’s income and will likely reduce the amount they will want to pay me for the franchise.
“I tried to discuss this with the franchise, but they said they couldn’t offer me any exception as it would violate the law. Is that right? I would hate to think that I spent all these years building a successful franchise only to find that I can’t sell it at the end of the day.”
Sometimes, you can be a victim of your own success, and this is a classic example.
When you buy a franchise (either a new or an existing territory), the deal doesn’t last forever. Your agreement with the franchise lasts for several years with the right to renew for an additional period. This is assuming the franchise is happy with your performance and you have generally behaved like a good franchisee. You can sell your franchise anytime you like to a buyer the franchise approves. However, the franchise is free to impose any terms they wish on your successor, even if those differ from the deal you had with them.
When a new franchise is just getting off the ground, they tend to offer extremely generous terms to their franchisees to get them on board. After all, the franchise hasn’t yet proved its business model, and early-stage franchisees are taking much bigger risks than those who buy in to the franchise later on.
The problem with doing that is after a while, the franchise looks less like a franchise and more like an agglomeration of entrepreneurs who are all doing their own thing. That creates both business and legal problems for the franchise, as it dilutes the brand they want to offer their customers.
At the end of the day, franchises are all about uniformity and consistency. A Burger King in Bangor, Maine, offers the exact same menu, decor and customer experience as a Burger King in San Diego, California, and all points in-between. To preserve the franchise’s brand recognition in the marketplace and make the franchise easier to operate at the corporate level, it is often necessary for the franchise to eliminate special deals and insist that all franchisees play by the same set of rules.
While a franchise cannot unilaterally change the rules that are spelled out in your franchise agreement, they are perfectly free to do so when your agreement comes up for renewal or when you sell your franchise to a new owner. That’s exactly what is happening here.
Normally, that’s not such a big deal, but, in this case, it poses a problem because of how successfully you have run your franchise.
With over $1 million in annual gross sales, your franchise will probably be valued in the $1 million to $2 million range, depending on how much of those sales translate into net income (earnings before interest and taxes). Simply put, there aren’t a whole lot of people with pockets deep enough to buy a business in that price range, and those that do have the money aren’t looking for a franchised service business.
Your prospective buyer is likely to be a downsized corporate executive looking to buy a job for a purchase price in the low- to mid-six figures that can be financed with proceeds of a Small Business Administration loan.
So, what can you do here? First, I would have a frank discussion with the franchise about your concern that the new fee structure will inhibit your ability to sell your territory. They cannot legally make a material amendment to their program that treats similarly situated franchisees differently, but they may be able to offer a discount or impose a cap on the new percentage royalties for “all franchisees making more than $1 million in gross sales.” This information can be found on the Federal Trade Commission’s Franchise Rule Compliance Guide.
They might also be willing to divide your territory into multiple territories, enabling you to sell each one separately for a price that middle-class buyers can afford.
Failing that, you should have your accountant prepare pro forma financial statements showing what your franchise would earn under the new fee arrangement and resign yourself to a lower fee than you would have gotten had this not been a franchised business upon sale.
Cliff Ennico (crennico@gmail.com) is a syndicated columnist, author and former host of the PBS television series “Money Hunt.”
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