Acquiring a Franchise? Here’s What You Need To Know For Successful Due Diligence

Brand acquisition can be an attractive growth strategy for franchisors and small businesses. Many small businesses find themselves at a ceiling after years of acquisition, and joining a franchise system equips them with the support and resources they need to continue scaling while bringing their product or service to more markets across the country. Franchisors, especially those looking to grow an existing system or build a multi-brand portfolio, can collaborate with these owners to propel their growth even further.

While it’s often a productive way to expand, the acquisition process is a serious one. It requires thorough due diligence on both ends to ensure a mutually beneficial deal is made. 

For Franchisors Acquiring and Rebranding an Existing Business, Considerations Around Integration Are Crucial

The process of bringing a new brand into an existing system requires many small changes that can quickly add up. Beyond considering whether the acquisition makes sense financially, the acquiring party should carefully determine what will be required to fully integrate the new brand into the existing one.

“The economics are obviously a big [factor]; everybody’s going to look at a P&L and the balance sheets to make sure that they’re understanding the numbers,” said Beck Miller, senior director of franchising at LaundroLab. “But one of the things that I think is constantly underestimated in terms of the lift and what goes into this is ‘What is the integration going to be?’ It’s hard to integrate customers that are used to a certain form of technology, a certain website, a certain point of contact — whatever it may be — into a different system that might have slightly different prices, slightly different turnaround time, slightly different standard operating procedures and so on.”

Miller noted that, when thinking about the integration process, the acquiring party should not shy away from recognizing what it brings to the table. If the franchisor has a robust technology stack that will support the long-term success of all owners in the system, migrating existing teams and customers within the acquired system to the new platform is worth the effort and risk of potential customer turnover.

“When we complete that transition, we’re not able to, in theory, get better unit economics,” Miller said. “So, if you’re just looking at a P&L, the numbers may not be as advantageous as you want them to be, but making sure that you’re factoring in what your team brings to the table post-integration from an efficiency standpoint is really important.”

Parent Franchisors Building a Multi-Brand Portfolio Should Pay Special Attention to Alignment in Purpose

HorsePower Brands CEO Tony Hulbert explained that the process of building a multi-brand home services franchisor company has required a commitment to the long-term vision and a discerning eye when considering which brands truly do align with the mission.

“It starts with ‘What is our initiative and our purpose?’” said Hulbert. “We are building a portfolio company focused on home services concepts, so we will not be in restaurants, retail, etc. We will always be in the home. I think it’s important, as you start to identify your acquisition opportunities, to identify where you want to be and what the long-term vision is.”

Hulbert said part of the strategy process involves thinking of the 10-year plan and working backward to determine the steps necessary to achieve it. While HorsePower Brands exists as a parent franchisor, the group’s long-term vision is to launch a consumer-facing parent brand, HOWIE.

“We want to be everything that has to do with the home. With respect to the homeowner, the end consumer, they’re going to look at the HOWIE brand that sits above all the brands,” he said. “So, if you’ve worked with Bumble Bee Blinds and had a great experience, you’re going to discover more services within HOWIE. That ties everything together for the franchisee and the customer, and that’s definitely tied into our acquisition strategy.”

When an Acquisition Leads to the Merger of Two Franchise Brands, Any Legal Implications Should Be a Key Consideration

While all franchises must operate within the bounds of the Federal Trade Commission Franchise Rule, there are some regulations that differ from state to state. A franchise should fully understand all of the protocols of the brand it aims to acquire as this can impact business practices, legal liabilities and disclosure requirements.

“Under the Federal Franchise Rule, there are franchise registration states,” said Carlos White, partner at Lathrop GPM LLP. “Let’s say a state like Arkansas — they don’t have any state-specific franchise rules. There’s no private right of action for an individual franchisee; they will have to depend on the FTC. Your risk profile in offering and selling franchises in Arkansas is a lot different than in California where a franchisee might have a private right of action and have an easier way to sue a franchisor.”

Franchise regulations like these make it especially important for the acquiring party to fully understand where and how the brand it plans to procure is doing business to get a full picture of the risk profile of the deal. 

“Another thing to be mindful of if you’re buying a franchise is that a lot of franchise companies have what they call an inadvertent franchise. They issue license agreements previous to developing their formal franchise program,” White said. “It’s important to understand not only the franchising program for the target business but also if they had any other licensing distribution-type programs so that we can take a further look to make sure those didn’t violate applicable franchise law.”

Another risk that should be assessed is the potential for any future liability.

“Technically, it depends on the structure of the deal. Typically, if you buy the equity of a company, the buyer is responsible for all of their liabilities,” White explained. “But as you can imagine, a lot of these companies negotiate and structure the deal so they can properly allocate who should be responsible for things that occurred prior to the deal.”

In cases like these, the support of an experienced franchise attorney can be an invaluable resource in ensuring the acquiring party is making a fully informed decision and not taking on unnecessary risk.

For Experienced Franchise Development Professionals, Acquiring Franchising Rights to an Existing Business Can Be a Lower-Risk Option

Transactions of this nature involve one brand purchasing another outright, but there are other pathways to growth through acquisition. Aaron Harper, now-CEO of Rolling Suds, took a less traditional approach: he independently acquired franchising rights to an existing business. The original founders kept their existing Rolling Suds business, and Harper became the CEO of an entirely new franchise entity.

“I created a different business with the franchise,” he said. “I didn’t acquire anything other than the trademark and the IP. I think that is the least risky situation for the founders because they get to keep 100% of their business, and all of the risk is placed on me as the franchisor. But it’s actually the least risky for me, too, because I can start it from scratch. I know what needs to be done.”

Sometimes, acquisitions take place when a franchisor feels it can reinvent a failing brand or lead a turnaround of sorts. While it’s possible, this is a very work-intensive process, and there is often friction between the new franchisor and existing franchisees.

For entrepreneurs looking to follow the same path he did, Harper said one of the most important considerations is your own experience and capabilities. He gave an example of someone who has an idea to go buy a landscaping business with no prior experience in landscaping or franchising. The owners of the landscaping business don’t have any franchise experience either, so it would be very difficult to turn that into a national brand through franchising.

“I had proven I could do it with other brands,” he said. “I became the franchisor. Me and my team, we did it all. I knew from the get-go that that’s what I wanted, so I just needed a model that I could replicate and that I believed could go in any market.”

In cases like these, due diligence should be more focused on the business model and industry outlook than the business acumen and potential contributions of the original owners.

Ideally, you should enter a fragmented but recession-resistant industry with a large total addressable market and a lot of customers. And, while it’s not mandatory, choosing a concept that has little-to-no competition in the franchise space can be another benefit.

“A lot of what I did was just going off of gut. You can make anything work on a P&L, but no one knew that we would sell 187 units in year one,” Harper said. “It has to be about ‘Do the people make sense, and does the business make sense?’ And if those questions are answered, and the answer is yes, let’s just figure out a way to get a deal done that makes everyone happy.”

Any Acquisition Is a Careful Balance of Risk and Reward

Growth through acquisition is a promising opportunity, but any investment also comes with inherent risks. By first choosing which acquisition approach makes the most sense for your circumstances, and then doing thorough due diligence to evaluate risks and verify claims made by the other party, you can make a well-informed decision that aligns with and brings you closer to your goals.