Growing a Franchise
Exiting a franchise agreement early can be costly. Franchise attorney Joel Buckberg explains the options for selling, terminating or closing a franchise while limiting financial losses.
A franchise owner may decide to leave a business for any number of reasons, but getting out of the agreement isn't always straightforward. Depending on the contract, an early exit could involve financial penalties, restrictions on future business activities and other legal obligations. For owners asking, "How do I exit a franchise agreement?" the first step is understanding what the contract allows and what it could cost to leave.
Franchise agreements are generally designed to keep owners committed for a set number of years, and leaving before the term expires may come with financial penalties. According to Joel Buckberg, senior counsel for the Nashville office of Baker Donelson who advises clients on franchising and business transactions, an early exit often depends on the terms of the agreement and the franchisor's willingness to negotiate.
"Unless the franchise agreement provides for an exit window, with or without conditions, options are usually limited to an efficient breach or paying a specified damage fee or liquidated damages," Buckberg said. "Some long-term franchises, like hotels, have exit windows at specified intervals or milestones. Shorter-term franchises (five- to 10-year terms) usually do not."
In many cases, the simplest way out is to sell the franchise to another qualified owner. This allows the business to remain open and may help the departing owner avoid some of the costs associated with terminating the agreement. The sale will typically need approval from the franchisor and may also require approval from lenders or landlords. Even then, the selling price may not be enough to recover the owner's original investment.
Franchisees may also have grounds to terminate if the franchisor has materially breached its contractual obligations. Buckberg recommends reviewing whether the franchisor has failed to provide promised support, allowed territorial encroachment or made substantial changes to the business concept. Such claims can be difficult to establish, particularly when the franchisor has an opportunity to correct the problem.
For owners considering how to exit a franchise agreement, selling the business may offer a better financial outcome than simply shutting down. Closing generally means losing most of the investment, with only the potential resale value of equipment and other assets remaining.
Selling to a qualified buyer who can continue operating the franchise gives the owner a chance to recover some of their investment while limiting potential claims from the franchisor, landlord and suppliers. If no buyer can be found, the owner could look into converting the location to another type of business, although any plans would need to account for noncompete restrictions that remain in effect after the franchise agreement ends.
Timing also matters. Buckberg estimates that a franchise sale requiring franchisor and landlord approvals can take 90 to 120 days from listing if everything goes smoothly. Owners who wait until their financial situation becomes critical may have fewer options and less negotiating leverage.
Rather than rushing toward termination, Buckberg encourages owners to examine their financial performance and determine whether operational changes could improve the business's prospects.
"Like all businesses, watching key performance indicators and working capital is critical, and action should be taken as soon as the business looks to be on an unsustainable path," Buckberg said. "Franchisors may be able to help with additional training, more support and perhaps financial relief rather than lose the outlet."
Reviewing expenses against the brand's benchmarks and assessing management performance could also improve the business's resale value or potentially eliminate the need to exit altogether.
Owners considering termination should start by reading their franchise agreement and the brand's current Franchise Disclosure Document (FDD). They need to know what the agreement says about ending the relationship or transferring ownership, what fees or other financial obligations they may still owe and whether they'll be restricted from operating a competing business after leaving.
Buckberg also suggests looking at the FDD's list of terminated franchisees and checking for past or pending lawsuits involving the franchisor. Reaching out to former owners can help franchisees learn what happened when others left the system and what difficulties they encountered along the way.
Owners should then open a conversation with their franchisor's field representatives or leadership team. The franchisor may be willing to provide additional assistance, negotiate an arrangement or help identify a qualified buyer rather than lose an operating location.
If you're considering an early exit, start by understanding your contractual obligations and the financial consequences of each available option.
Exiting a franchise agreement can take time, and the best approach will depend on the contract, the business's financial condition and the franchisor's willingness to cooperate. Planning ahead gives owners a better opportunity to protect their interests and make an informed decision about what comes next.
For more information on selling a franchise business, check out these related articles on 1851 Franchise:
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