It is a win-win when the franchisor suggests or require that a franchisee have a succession plan. By raising issues that most franchisees do not want to confront, all parties can collaborate on a business contingency plan which benefits everyone. Although cases alleging age discrimination in franchising are rare and perhaps rising, a succession plan may avoid such claims by focusing on long-term goals and a strategy on how to achieve those goals. I strongly recommend that all franchisors require their franchisees of over two years to have succession plans, even if they are not shared completely with the franchisor, because it helps with continuity so essential to brand equity.

The succession plan need not be complicated nor does it necessarily require accountants and lawyers. A succession plan just looks at what will happen if the owner leaves by death or otherwise. It asks the question, what is the best way to a planned exit, and what happens on an unplanned exit?

The succession plan may be coordinated with an estate plan, which contemplates dispositive transfers through sale and other means. The disposition can also occur by wills and trusts, buy-sell agreements, augmented by life insurance and family partnerships. A valuation of the business is often a key element in any exit strategy, and the succession plan, estate plan and valuation should be coordinated. These issues need to be coordinated with any restrictions that may exist under a franchise agreement on sale or disposition. In addition, state law may invalidate or alter some of these restrictions. For these reasons, the succession planning probably should be coordinated with lawyers familiar with both franchise law and estate planning.

Confronting Business Facts

A strategy requires planning, usually three years in advance. Planning may be hindered if the franchisee has no valuation for its business. Their books and records need to be organized. They need to do this while they are still committed to the business and understand that the benefit of being fully invested of time and effort in the business. They also need to understand how the business will grow, or continue to operate, when they are no longer in the business.

Confronting the Key Questions

• How will the business continue if the operator unexpectedly exits, becomes incapacitated or dies?
• Should the business be continued or liquidated in the unexpected exit of the operator?
• Would it be better if the business were sold in a planned sale?
• In the absence of the operator, who will be on the making these key decisions and should a team be established now?

Considerations of Franchise Law

The first consideration is coordination of the operator's succession plan with the restrictions in the franchise agreement. Franchise agreements generally prohibit sales to competitors and may grant the franchisor an option to purchase upon notice of sale or death. These restrictions may or may not be enforceable as written as a matter of contract law or antitrust law. These restrictions may also not be enforceable as written because of state laws governing the decedent's estate. These restrictions may also not be enforceable as written because of state franchise law which in some states, increases the ability of franchisees to sell their business during their life, or after their death. Proper planning requires a look at all of these considerations.

The Role of Valuation

Valuation is important because it allows the operator to calculate their total estate and allocate based on value. Valuation helps with tax planning by pricing the assets and allowing a tax strategy to be formulated. The franchise community has specialists in tax planning and valuation, such as Franchise Valuations Ltd. in New York and many franchise business brokers have ancillary services.

Make the Decisions

For the next generation, will ownership be separate from management? If the business is transferred to the children, do they have the experience, skill and motivation to take over? If not, the compensation plan to retain key employees needs to executed now.

Who will be on the succession team and trusted advisers? These specialists should include a franchise attorney, CPA or financial advisor, valuation specialist and a tax savvy estate planning attorney, Judgment calls need to be made and the franchisee needs to be well informed.

Resolving conflicts between active and passive owners are frequent in family owned businesses. Non-active family members want tax-advantaged dividend distributions and capital gains from the sale of the company. Active family members believe their efforts support the family and want to be paid for their work directly, rather than receive dividends diluting their direct compensation. Conflicts can be minimized by providing transparency in the books and records and to have a mechanism for buy-outs of dissident shareholders. Where generational differences regarding control, it may not be wise to have the elders “rule from the grave.” Recapitalization to give seniors preferred stock to maintain control while allowing the younger generation to acquire control may be the best practice to insure a passing of responsibility.

Employee succession can be executed through an employee stock ownership plan or ESOP, which allows employees to purchase and own stock of the employer. A life insurance can trust can help provide tax advantaged payments to children not active in the business as a means of wealth transfer.

As Benjamin Franklin said, “Those who fail to plan, you are planning to fail.” Make those decisions early, and with good counsel to maximize your goals.

Craig R. Tractenberg, a partner at Fox Rothschild, handles complex business disputes involving intellectual property, licenses, business torts and insolvency issues. He focuses on franchise companies' development and expansion. Contact him at [email protected].