There now seems to be a more robust market for acquisitions and mergers in the franchise world. There has been pent up demand (particularly for franchisee units) and many franchisees have been waiting to sell their units. Even though there is still a tight senior debt market, deals (and lots of deals) are getting done with the influx of private equity and large franchisees wishing to grow.
In light of this activity, this month’s column will outline key thoughts about structuring and closing a deal:
1. Determine what you are buying or selling. This is a key element. Sometimes there is a difference of opinion between buyer and seller as to what is being bought. Often there are assets on the seller’s balance sheet that are not part of the operating business. Also, there may be under-performing units that should not be sold as a part of a larger deal. With that in mind, ask the following questions:
A. Is real estate included?
B. Are all stores included, even bad ones (which may substantially reduce your price)?
C. Are development rights included?
D. Are personal assets excluded?
E. Are current assets (cash, accounts receivable, prepaids and inventory, etc.) included or paid for separately? What about credits or rebates that are not yet paid?
F. What is the treatment of gift cards and credit card receipts in transit?
2. Structure. Structure can be the single most important aspect of net proceeds except for price and needs to be carefully reviewed. Structure is more than just a question of stock or membership vs. an asset deal. Here are some questions to ask about structure:
A. Are you going to do a stock or membership deal or an asset deal? (This is not only a tax decision but may be a way to deal with assignment issues.) There are several ways to deal with tax issues, including certain tax elections, even if it is a different structure than you would like.
B. Is it possible to do a merger?
C. Is it possible to do a part asset sale and part stock or membership deal?
D. What are the concerns of the buyer in being a successor?
E. Is there an ongoing relationship that may allow for other types of consideration to be paid?
3. What is the price? More time is spent on pricing than any other issue. The pricing issue is really a product of due diligence. An initial price is usually established and due diligence proves out to the buyer if its assumptions are valid and the buyer feels comfortable paying the offered price. Here are some questions to ask about price:
A. Is the price fixed or floating until closing (such as a multiple of EBITDA)?
B. Are there automatic adjustments for items discovered during due diligence?
C. Are current assets paid for at cost or fair market value?
D. What are the walk-away rights if the parties cannot come to agreement on price at the end of due diligence?
E. Is the price a bait and switch, where there is a high price offered (particularly in the letter of intent) but in the end the price will be lower?
4. What liabilities are assumed? Assumed liabilities tie out to pricing, and this area needs to be understood. Many times assumptions are not correct. We normally want to see an attached schedule of assumed liabilities. Here are some questions to ask about liabilities:
A. Are just post-closing liabilities assumed?
B. How is vacation pay treated?
C. Are employee benefits assumed?
D. Are vendor contracts assumed?
E. Are equipment leases assumed?
F. Are software leases assumed?
G. What franchisee obligations (such as remodels or development obligations) are assumed or renegotiated?
5. Due diligence period. The due diligence period can be arduous and painful for the CFO. It is also a time when there is uncertainty within the seller’s company. During the due diligence period, the seller needs to take steps to assure some type of continuity and ability to perform to closing. Many times pay-to-stay agreements during the due diligence period are appropriate so that the transaction can move ahead. It is key during the due diligence period to determine the information being provided and what the outs are if the due diligence reveals something the buyer cannot live with. Here are some questions to ask about the due diligence period:
A. How long does the period last?
B. What does the seller have to provide?
C. What kind of access to people is required?
D. How do you maintain confidentiality?
E. Is there earnest money prior to the start of due diligence?
F. What are the walk-away rights for both parties?
A. Financing contingency. When does it end, and is money available?
B. Franchisor approval
C. Hiring the seller’s employees
D. Lease assignment and landlord consents
E. Certain waivers from third parties
F. Agreeing to non-solicitation and non-compete agreements
G. Release of seller from agreed-to liabilities
8. Indemnification. Too much time is spent on indemnification. Good buyers and sellers normally arrive at effective indemnifications. Indemnification should not be open ended and last forever. Also, it should have a cap. Here are some questions to ask about indemnification:
A. To what extend is each party indemnifying the other party?
B. What are the caps on liability?
C. Is there a basket of liability before the seller is liable?
D. How long does the indemnity last?
9. Closing. Closing is a process. There are items that have post closing adjustments because they cannot be determined at closing. These items include inventory costs, certain accruals and assumed liabilities. Seller paper or carried interest need to be worked out and provided for in separate documents at closing. This also pertains to non-competes and non-solicitation agreements. Here are some questions to ask about the closing:
A. What is paid at closing?
B. Is there an escrow?
C. Is there seller paper or carried interest?
D. Are there any post closing adjustments?
The above items are a good starting point. The most important thing is to have a comprehensive, detailed checklist and timeline of all the items that need to be done. A buyer needs to have strong financial counsel. A seller needs to involve its CFO and HR people to make sure information is fully disclosed.
If you would like a detailed checklist or form agreements and letters of intent, please let me know. We can direct you to the right sources or provide helpful information.