Owning and operating a business is intrinsic to the American Dream. However, many people shy away from the risks involved in starting a business. Instead, they will consider buying into a franchised operation because they think the proven business concept, in-place systems, and available support network decrease their risk and increase their likelihood of success.
Franchising is a vital part of the American economy both for entrepreneurs and for the work force. Many individuals across the country (and the world) have been massively successful with franchised businesses. And just like with family-owned small businesses, franchises come with a certain set of risks, especially as it relates to estate planning.
Obstacles to Franchise Business Succession Plans
The challenges facing franchisees are different from those of a family-owned business because the rights and obligations of a franchisee are determined by the franchisor in the Franchise Disclosure Document (FDD) and the Franchise Agreement. One of the most underappreciated franchise risks is business succession.
Pro Tip: Strictly speaking, “franchise,” “license,” and “business opportunity” aren’t synonyms. But for our purposes, business licensing and business opportunity arrangements also face these business succession issues due to their legal relationships to the licensor or opportunity provider.
Unlike other assets or a family business, the transfer of your ownership interest in a franchise may be restricted by provisions in the FDD and Franchise Agreement, which set out your rights and the legal relationship between you and the franchisor.
You may find that the FDD and Franchise Agreement impose stringent limitations on such a transfer. In the most severe case, ownership transfer may be prohibited outright. If a transfer is allowed, its approval by the franchisor may be contingent on various conditions. For example, the potential transferee may be required to:
- Formally apply for the transfer,
- Undergo a background check or other means of assessing qualifications (e.g. personality tests, financial reviews),
- Meet burdensome financial and operational criteria (e.g. have sufficient liquid assets or attend company training)
- Sign a new Franchise Agreement or provide a personal guarantee.
If these contractual requirements are not satisfied, the franchisor may deny the transfer to your beneficiaries. In short, including a franchise business interest in your will or trust is likely to be insufficient to ensure ownership transfers to your heirs.
Determining the Future of Your Franchise
The first step to take when you are approaching business succession planning as a franchise owner is to review the relevant contracts and agreements. Every FDD contains 23 disclosure items that lay out your rights as a franchisee. A few of these may directly impact your succession planning:
Item 9: Franchisee's Obligations
This item contains information on the franchisee’s legal obligations as per the Franchise Agreement. These legal issues include renewal rights, non-compete and confidentiality requirements, termination rights, and forum selection provisions.
Item 15: Obligation to Participate in the Actual Operation of the Franchise Business
Item 15 discloses the franchisee’s obligation to personally run and manage the day-to-day operation of the franchised business. If other managers can run the business, it must disclose any restrictions on who can be hired as daily management.
Item 17: Renewal, Termination, Transfer, and Dispute Resolution
After you have thoroughly reviewed your franchise contracts to determine the legalities of ownership transfer, you should have a conversation with your family and children to gauge whether anyone is interested in taking over your franchised business. If the thought does not appeal to any of your heirs, you still have time to prepare your franchise for sale to an outside third party.
Pro Tip: Certain industries have internal regulations on ownership that could impact your estate planning. For instance, a law firm can only be owned by a lawyer, so transferring ownership interest in a firm to your non-lawyer spouse (even if she’s willing to take over) is not allowed. CPAs and accountants, architects, and other professional service providers may have comparable restrictions. Franchises in these areas (e.g. H&R Block) may be even more difficult to fit into an estate plan. This is why having a business succession plan in place is absolutely vital.
Moreover, as we saw above, potential transferees may be required to jump through a number of hoops before the franchisor will approve a transfer. An early discussion about business succession gives the potential transferee the opportunity to prepare and satisfy the contractual obligations of the transfer.
Such a conversation, even if difficult and sensitive, will help forestall family conflicts, keep the business running smoothly, and ensure your heirs receive the maximum benefit from your hard work.
If Not Now, When?
Business owners are busy. In their free time, they don’t want to think about business succession planning. Unfortunately, avoiding this vital topic doesn’t make it disappear; it can even lead to significant harms in the future for your heirs. So, ask yourself, “If not now, when?”
Given the disruptions we’ve all experienced over the last year due to the ongoing pandemic and the impending changes to the tax code, we believe now is the perfect time to think about the future of your business assets.
We urge you to take the necessary steps to protect yourself, your family, and your hard-earned assets and wealth. Whether you need to develop your first business succession plan or update your existing plan, we can help take the fear and frustration out of the process. Call us today or fill out the confidential form below to schedule your free Financial Legacy Review now.