The franchise law group at Cassels routinely represents diverse stakeholders involved in various types of franchise transactions in the M&A and financing sectors. In the past year alone, we have acted on upwards of a dozen separate transactions of varying size and structure, as COVID has catalyzed activity in the industry. While some franchisors have been stagnated due to the current global pandemic, others are seeing the economic upheaval as opportunistic, and moving forward with transactions that might not have otherwise occurred.
So, with this increased activity in the space, our team has performed more due diligence on franchise systems in the past few months than we had in the past few years combined, and we find ourselves coming back to some of the same roadblocks on many of these transactions. The process for conducting due diligence on a franchise system would be so much more efficient if the franchise systems we were investigating had a better understanding of precisely what prospective buyers (and their counsel) will be looking for, and thereby maintained and provided their records and paperwork in accordance with that understanding. Not only would this orchestrated and organized approach reduce the associated professional fees with performing the necessary due diligence, it would actually also very likely increase the purchase price for the franchise system, as issues or omissions in the records and paperwork can lead to liabilities in the system that directly impact its value. Put differently, it pays to heed this advice!
If you ask yourself, what is the true asset being acquired or encumbered in these franchise transactions, you could narrow the response and simply state: paper. Of course, that is an overly simplistic view of the true assets of any franchised system, but, there is value in this framework as it impacts the way in which franchisors should think about record keeping and document management systems. Your paper, more specifically your franchise agreements, trademark licenses, and disclosure documentation, to name just a few, are the assets of the franchise system that a potential buyer is looking to acquire. Just like you would take your car to a carwash before listing it for sale, so too should you polish your paper and records before shopping your franchise system.
So, with that simplistic approach to franchise transactions and due diligence in mind, I want to highlight here the top ten things that prospective buyers, and their franchise lawyers, will be looking for when they diligence your franchise system so that you can better prepare yourself for the ensuing onslaught of email and document requests:
1.The Master List
Each system should maintain a master list of all franchisees that includes the material terms for each individual franchisee. Things like parties names, dates, addresses, term length, renewal terms, amendments, and evidence of disclosure, are all categories that should be included, in addition to some of the considerations that follow.
2. The Rescission Risk List
In order to properly ascertain the liabilities of any franchise system in Canada, there should be a clear list of all franchisees that were granted new franchise rights in the last two years in a regulated province (and potentially longer, as there is currently a risk that the freezing of limitation periods in certain province’s due to COVID might extend this period). A well curated Master List can help easily facilitate the preparation of this list.
3. Copies of FDDs and SMCs
While evidence of having received disclosure will be crucial, as discussed in the next point, the underlying disclosure needs to have been compliant with the law in the first place. We routinely review representative forms of FDDs from each of the last few years, as well as a selection of customized FDDs and SMCs from one-off transactions (and more, client permitting). Best practice is to save a copy of each and every FDD and SMC that is delivered to each franchisee.
4. Copies of FDD and SMC Receipts
What’s the good in having a compliant FDD if you can’t prove that franchisees have been receiving it! And remember, the FDD and SMC receipts should be signed by all parties to the agreements, whether franchisee entity or personal guarantors, at least 14 days prior to the execution of any agreements or payment of any funds (less some exclusions for pre-disclosure deposits, in certain circumstances).
5. Alberta Guarantees Acknowledgement Act Certificates
In order for a guarantee to be enforceable in the province of Alberta, the guarantee must also include an executed Guarantee’s Acknowledgment Act Certificate. As this requirement is unique to Alberta, it can often be overlooked, and is a crucial part of the due diligence if the system has contracts with guarantees governed by Alberta law.
6. Franchisee Advisory Council Communications
Obtaining all available information (meeting minutes, email communications, formal notices, etc.) on any existing franchisee advisory councils is an excellent method of understanding the zeitgeist of the historical franchisor-franchisee relationship and can often be the first indication of trouble brewing within the system.
7. Email Communications and Notices of Default
All contentious email communications and notices of default should be grouped together and presented in an organized manner so that buyer’s counsel can efficiently gain insight into the problematic franchisees of the system.
8. Advertising Fund Statements
Many franchise agreements will provide that franchisees can review a statement regarding the operations of the advertising fund on request, and it’s imperative that the accounting of the fund be in order, and also, in line with past disclosures in the FDD.
9. Historical Sales Information
This is of course one of the most important items from a business due diligence perspective, and buyer’s counsel will want to see clear franchise by franchise breakdowns of historical sales information from within the system.
10. Broker Agreements and Sales Brochures
As we often tell our clients: the way in which you use your FDD to sell franchises matters as much as what’s included within the FDD. Broker agreements, sales brochures, and other documentation that can provide insight into the sales process and sales materials will be crucial for understanding potential liabilities that might be lurking underneath the hood.
Noah Leszcz is a partner in the Franchise Law and Business Groups at Cassels. Noah practices business law, with a focus on franchising, licensing, distribution, mergers & acquisitions, emerging companies, and intellectual property. He works with a diverse group of franchise and distribution companies, assisting with legal and regulatory issues, contractual drafting, intellectual property, and compliance with Canadian franchise disclosure legislation.