Franchise Resale Diligence: Nothing Arrives By Right

A buyer of a new franchised unit is handed the franchisor’s disclosure document at least 14 calendar days before signing anything, because 16 CFR 436.2(a) makes failing to do so an unfair or deceptive practice.

A buyer of an existing unit is generally handed nothing by the seller. Under the Rule that seller is not a “franchise seller”, so the duty that produces that document does not run through them.

The franchisor is a separate question, and a live one. The Rule’s carve-out for transfers applies only where the franchisor has “no significant involvement” with the buyer, and three of the four transfer provisions we have read on this site require the buyer to sign the franchisor’s current agreement, qualify, train and pay it a fee. So do not treat “it’s a resale” as meaning no disclosure document is ever coming. Ask.

Everything below exists because of that gap. We are an independent publisher, not a franchise broker and not a law firm, and this is a starting list rather than a complete diligence process. Your attorney, accountant and property adviser will add items specific to your transaction that this page does not cover.

Stage one: the four documents to request before spending anything

Ask for these before you commission a survey, a lease review or an accountant. They are cheap to request and any one of them can end the conversation.

1. The franchisor’s current disclosure document. No federal duty obliges the seller to produce it, so treat the response as information in itself. A seller who cannot or will not produce the document their own business operates under has answered a different question than the one you asked. You may not have to rely on them at all: some states publish disclosure documents free and in full.

2. The seller’s own franchise agreement. This is the request that is easiest to overlook, and it may matter more than the disclosure document. The disclosure document tells you the terms on offer today. Only the seller’s agreement tells you the terms that produced the trading history you are being shown. In three of the four agreements we have read the buyer signs the current form rather than inheriting the seller’s, which means the two documents can differ on royalty, marketing fee, term length and renewal.

3. Item 17 of the current disclosure document. The transfer provisions. Smoothie King’s runs to nine separate conditions, several of which land on the buyer and cost money.

4. Item 20’s transfer table. Item 20 reports transfers by state for each of the last three years. That is a system-level answer to a question the seller cannot give you neutrally: how routinely units at this brand actually change hands.

Stage two: the questions no disclosure document answers

The disclosure document describes the system. None of it describes the store you are buying. These are the unit-level questions, and each one needs a source outside the FDD.

Why the seller is leaving. Ask it first, ask it plainly, and then verify it independently against the unit’s records and the franchisor’s account of the relationship. Nothing requires an accurate answer.

The unit’s compliance history with the franchisor. This one has teeth. Smoothie King’s Item 17 conditions include that all monetary and other obligations are satisfied and that the franchisee is in compliance with the agreement, and Kung Fu Tea’s likewise require that the franchisee is in compliance. Those attach to the seller, not to you, which means a seller’s own default can block your purchase. Ask the franchisor directly whether the unit is in good standing, rather than asking the seller.

The lease. Remaining term, renewal options, rent escalations, and whether the landlord will consent to an assignment. A franchise agreement with ten years left, sitting on a lease with two, is a different proposition from what it appears to be.

The equipment. Age, condition, service history, what is owned outright and what sits on a lease or finance agreement that may not transfer with the business.

Any required remodel or upgrade. Smoothie King’s transfer conditions require the transferee to remodel the premises. That is a capital cost arriving at the moment of purchase with no specification and no amount stated anywhere in its Item 17, so establish the current image standard with the franchisor and price the work with a builder before agreeing terms. Not every brand states a remodel condition, so check your own.

Training obligations and their cost. Both disclosure documents cited here require training on transfer: Smoothie King requires the transferee to complete training, and Kung Fu Tea requires a new manager to be trained and charges a separate $5,000 re-training fee, described in its Item 6 as a five-day training course for the buyer of your business. Ask whether training is charged separately, how long it runs, and where it takes place.

Staff. Who stays, what they are paid, what they know, and whether any of them hold the relationships the unit runs on.

Stage three: the two clocks that can end the deal late

Both of these can terminate a purchase after a buyer has spent real money.

The right of first refusal. Smoothie King’s first condition for approving a transfer is that Smoothie King does not exercise its right of first refusal, letting it match your offer and take the unit itself. Smoothie King, Freshii and Kung Fu Tea each reserve one and none of the three states an exercise deadline in Item 17. F45 Training’s does state one, at 30 days’ written notice, which is the useful reminder that this number exists and differs. Get the section number and the day count in writing before you commission anything expensive.

The approval process. Smoothie King’s Item 17 sets out nine conditions and states no timeline for working through them. Ask the franchisor for a typical elapsed time and what causes delays, and get it before you agree a closing date with the seller.

The order matters. Both are cheap to ask about and expensive to discover late, which is why they belong ahead of the survey and the lease work rather than after them.

Stage four: state law, and one state that changes the answer

If you are buying in New York, the seller’s own registration exemption is conditioned on giving you disclosure. New York General Business Law Section 684(5)(c) requires the franchisee to furnish the prospective purchaser a copy of the franchisor’s currently registered offering prospectus “at least one week prior to the execution of any binding contract or purchase agreement, or at least one week prior to the receipt of any consideration, whichever occurs first.”

California, Washington and Illinois state no equivalent condition on a franchisee’s own resale. Those are four states out of fifty, and nothing here establishes how the rest treat it. Which state’s law governs your transaction is a question for a franchise attorney, worth asking at the start rather than the end.

What this page will not do

It will not tell you what a unit is worth, what to pay, or what to offer. That work belongs with an accountant who has seen the books and a broker or valuation professional who works in the category, and it is outside what a website can responsibly do.

What it can do is make sure that when you get to that conversation, you are holding the documents rather than hoping someone hands them to you.

The request list, in order

This is a starting list. It is not complete, and it does not cover items your own advisers will identify, including litigation history, insurance claims, health-inspection records, tax liabilities, and vendor arrangements.

• The franchisor’s current disclosure document
• The seller’s executed franchise agreement
• Item 17 transfer conditions, and the section numbers they cite
• The right-of-first-refusal exercise period, in writing, by section number
• The franchisor’s typical approval timeline, in writing
• Written confirmation from the franchisor that the unit is in good standing
• The lease, with remaining term, assignment clause and landlord consent process
• Equipment schedule, with age, condition and any finance or lease agreements attached
• The current image or remodel specification, and whether this unit complies
• Training requirements, duration, location and whether charged separately
• The transfer fee and every other charge falling on the buyer
• Item 20’s transfer counts for the last three years
• Staff list with roles, tenure and pay
• Confirmation of which state’s franchise law governs the sale

Questions to ask a franchise attorney

• What disclosure am I entitled to in this transaction, and from whom?
• Is the franchisor’s involvement here more than approving or declining me?
• How do the seller’s agreement and the current form differ, clause by clause?
• Which transfer conditions attach to the seller, and what happens if they are not met?
• How long does the franchisor have to exercise its right of first refusal?
• What happens to my deposit and my diligence costs if the franchisor refuses approval?
• Does the lease assignment need landlord consent, and what happens if it is withheld?
• Am I taking on any of the seller’s liabilities, and how is that structured?