Sell-side merger considerations for franchises in 2022

Transaction activity for franchisees has continued to grow and has become fast-paced in the last few years.

Owners and investors need to understand the implications of a transaction on their bottom line as well as what they need to do to get results that align with their personal and professional goals.

Here, we’ve highlighted a few significant areas of consideration for franchisees to keep in mind as they consider the possibility of a full or partial exit. While not all-inclusive, these areas should offer some general guidance to help ensure the best possible outcome for you and your business.

1. Preparation

We’re sure you’ve heard this before, but it’s never too early to prepare for the sale of your business. Even if you’re not considering an exit or entertaining the idea of bringing in a new investor, time moves, desires change and opportunities arise.

Getting your house in order can take longer than you think, and since a sale event will likely be a dramatic inflection point in life, it’s important to consider which steps should be taken ahead of time to maximize value and minimize risk to you and your investors.

If not already, forward-looking financial information should be introduced to increase visibility into how your enterprise is expected to perform into the future. These forecasts and models will provide the analytical foundation and scenario analysis needed for decision-making and strategic direction, allowing you to optimize value creation and the appropriate timing of an exit event.

Forward-looking financial information should also fuse with wealth strategies, another important area to focus on in advance. Remember, there are three at the table with any exit: the seller, the buyer and the U.S. Treasury. The seller should consider estate planning and asset protection approaches beforehand. If you’re considering these strategies after a transaction event, you’re too late and have likely missed a significant opportunity.

The preparation phase also offers opportunities to examine and act on possible risk exposures that may be later identified during a buyer’s due diligence process, likely leading to a reduction or deferral of purchase price, resulting in a reduction to your return on investment. While not all-inclusive, you should consider the following: tangible personal property tax, tanning excise tax, Affordable Care Act (ACA) compliance, payroll and benefit compliance, and financials that may not be using generally accepted accounting principles (GAAP).

For these important decisions, it’s wise to consult qualified advisors, such as attorneys, accountants and investment bankers, who can provide significant value by helping you understand your options, avoid making emotional decisions and protect your best interests. The sooner you can bring these advisors into your inner circle, the better equipped you’ll be to navigate the life cycle of the transaction.

2. Execution

Executing to a high degree is not characterized by whether you successfully consummate a transaction, but rather, by your ability to capture the highest enterprise value, the most desirable tax treatment and the largest sum of after-tax proceeds.

This starts with the letter of intent (LOI), as the terms and conditions included in (or excluded from) the LOI will highly influence your outcome. Buyers will use this to their advantage, and once you’ve signed the LOI, your ability to influence a change in terms significantly reduces. Thus, if you haven’t consulted with your advisors already, it’s imperative that you do so prior to signing, to best maximize your upside.

The more terms you agree to in the LOI upfront, the better you position yourself for a speedy and successful transaction. Some of the most important considerations are those related to business valuation, economic structure, tax structure, asset allocation, deal definitions, and any working capital or other performance targets. By understanding how each of these impacts the sum of cash you’ll walk away with (and when you receive it), you can minimize your exposure to missteps that could reduce you and your family’s future financial wealth.

Once the LOI is signed, the buyer will have a window of time to perform due diligence processes on your business. This is where the steps taken during the preparation phase really start to pay off. Being able to provide the buyer with a clean, organized history of financial data in accordance with GAAP coupled with robust forward-looking financial information will offer the buyer essential information needed to support the valuation placed on your business.

Not only will the buyer be focused on their return potential, but they’ll be assessing the level of risk assumed through the transaction. If you have unaddressed “skeletons in the closet,” the buyer is likely to uncover them, leading to potential delays in closing as they weigh any risks being assumed. Remember, time kills deals, so if you can’t close the transaction timely, you open yourself up to a possible reduction in value. In the extreme, a buyer may walk away from the deal. Bottom line: The more time that passes, the more opportunities there are for other variables to come into play, potentially altering the transaction outcome.

3. Follow-through

Congratulations! You’ve closed the transaction and sold part or all of your business. It’s not over though, and there are two major considerations post-closing.

The most immediate, particularly in this high-inflation environment, is how to invest your cash proceeds, while maintaining a liquid reserve for use in settling your capital gain tax liability. If you’ve been working with your financial advisor and accountant throughout the preparation and execution phases, you’ve likely already begun discussing your short-, mid- and long-term financial needs and goals. Good advisors can provide forecasts of how you can expect your now-liquid wealth to grow, considering your life aspirations, spending expectations, tax liabilities and potential new active investment opportunities. If you haven’t prepared in this manner yet, it’s important to move, as inaction can have lasting downside effects on your long-term financial wealth.

The second major post-closing consideration relates to closing the books, settling working capital differences and reporting the transaction to the tax regimes. The member appointed as the seller’s representative is responsible for navigating this process, and it’s important that the representative work closely with their accountant to understand how to best satisfy reporting requirements and tax payments. Keep in mind, the more attention given to maintaining clean books during the preparation phase, the easier and more efficient this process will be.

Finally, don’t forget that if your business was run as a flow-through entity, both the entity and investors will need to consider compliance implications. The sale will be reported on both a final entity tax return and on each of the investors’ income tax returns.

As you consider what the future holds for you and your franchise, we can’t stress enough the value of preparation. Even if an exit seems years down the road, take the time now to gather your advisors and outline a strategic plan that will help you navigate the transaction process in the most operationally efficient and financially advantageous manner possible.

Good luck!

A version of this article was originally published in Geared Up, the official magazine of the Planet Fitness Independent Franchisee Council, and is reprinted with permission.