Multi-Unit Franchisees and Area Developers
Multi-unit and area development agreements are two more aggressive ways to grow a franchise system. However, with these endeavors come higher stakes and less margin for error. Multi-unit franchisees operate several franchise units and of course, take on the risk of each individual unit. Area developers obtain the right to develop a particular area within a certain time frame and usually have a predetermined amount of franchise units which they must develop. There is typically a development schedule that the area developer must abide by when managing its time to get the franchise units up and running. Entrepreneurs wishing to acquire and operate multi-unit franchises or adding to an established franchise system through area development will need to consider very particular aspects of the proposed transaction before any party can put pen to paper.
If a franchisee wants to open multiple franchise units, there will be need to be extensive negotiations of franchise agreements prior to taking on the burden of developing the system. The franchisee and franchisor will likely determine a schedule or timeframe for when each unit is expected to open. Alternatively, a potential purchaser may be looking to acquire multiple units of an existing franchisee, which can prove to be very complex. The due diligence required can be intensive in order to ensure that a purchaser is aware of any and all risks in acquiring the business before making such an investment. The purchaser should review the business records to assess performance, assure that the business is in compliance with all necessary licensing and tax matters, and learn of any liabilities that would be detrimental to the system. Other documents to review will include reviewing all existing franchise agreements and any amendments or renewals and existing contracts with third parties, including independent contractor agreements, supply agreements, and employee confidentiality agreements. Some of these agreements may be assumed. Others may have to be re-negotiated or renewed, which of course involves more work in order to close the acquisition.
Perhaps the most common of these third-party agreements are commercial leases. If the franchise units are operating out of a leased space, a purchaser will want to review the lease agreements to assess not only the business terms (costs of rent, utilities etc.) but also terms affecting the tenant’s occupancy – such as the length of the lease, relocation provisions, and renewal options. If a purchaser assumes an existing lease which has a term ending in the near future, one would want to make sure that the lease includes an option to renew (assuming the purchaser wants to remain in the space).
Similarly, acquiring rights as an area developer will involve careful due diligence. A purchaser should expect extensive negotiations with franchisors concerning development agreements and development schedules. An area developer will likely want to set up a development entity. Legal counsel can assist in determining what type of corporate formation will best fit the developer and will negotiate draft and review corporate governance agreements, such as operating agreements, bylaws and partnership agreements.
In either instance, due diligence prior to acquisition is of utmost importance in order to assess the risks involved with taking on a multi-unit franchise or area development investment. While there is great potential for success in acquiring the right business, the risks involved can be high and need proper assessment to minimize exposure to financial jeopardy or even potential litigation.