What Happens To Your Franchise When Your Franchisor Gets Bought Out?

By Lynn Beresford

Entrepreneur, Franchise News, New Deal, The Small Business Authority, December 1995

Hearing that your franchisor is being bought out can be nerve-wracking news for a franchisee.  What should you expect?  Will conflicts arise---especially if the acquiring company is a competitor? Fortunately, franchisees' worst fears don't always come true.

Being acquired can sometimes be a smooth transition for franchisees---and may even benefit them. Brad Dionne had been a Merry Maids franchisee for a year when in 1988, Merry Maids was acquired by ServiceMaster, a well known $4 billion company.  At the time of the Merry Maids acquisition, ServiceMaster also purchased three other home-care service companies - Terminix, TruGreen-Chemlawn and American Home Shield--all of which ServiceMaster now operates independently under their respective names.

Dionne admits to feeling apprehensive when he first heard about the sale of Merry Maids.  "We were a close-knit, family-type organization," he says. "So when it first happened, I was thinking, 'Is this close-knit feeling going to disappear? Is our support going to be gone?'"

The acquisition process, however, proved to be a pleasant one for Dionne.  He says ServiceMaster had an "if it ain't broke, don't fix it" philosophy and let Merry Maids operate on its own, continuing to develop a support system and encouraging a family feel.

In the end, Dionne says, the acquisition actually benefited him as a franchisee.  "Traditionally, the house-cleaning business has not been seen as big business; it's been viewed as a business that's easy to get into," he explains.  "Since the acquisition, the housecleaning business had [been seen as] more legitimate."

Rough Transition

Not all transitions are so seamless.  When Beth and Robert Pine opened a Clucker's Oak Roasted Chicken franchise in March 1994, the quick-serve chicken restaurant concept was just beginning to hear up, and the Pines thought they were getting in on the ground floor of the next big food-service craze.  But as it turned out, their unit was in business for only seven months.

Four months after their New Providence, New Jersey, restaurant opened, Beth Pine found out from her stockbroker that the Clucker's chain was being purchased by a larger, more powerful competitor---Kenny Rogers Roasters.  But the Pines never got a call or letter from their franchisor informing them that the sale had taken place or explaining how the transaction would affect franchisees.  By Beth's account it took " few thousand phone calls to Clucker's and Kenny Rogers Roasters before the Pines got any answers about the sale of their parent company.

When they finally spoke with Clucker's, the Pines were given three options: continue to run chicken restaurant under the Clucker's name without receiving any franchisor support, operate an independent chicken restaurant, or convert their existing restaurant to the Kenny Rogers Roasters format---at a cost of approximately $75,000.

The Pines didn't think any of those were viable options.  In October 1994, after store sales had begun to sag and local competitions had become fierce, the Pines closed their Clucker's.  "We were ready for a nervous breakdown," says Beth.  In December 1994, the Pines filed a lawsuit against Clucker's charging the company with, among other things, fraud.

Legal Matters

The law in this area of franchising is far from cut and dried.  Whether or not franchisors are legally obligated to inform their franchisees---and prospective franchisees---about any sales of the franchise system hinges on several slivers of information.

Robert Zarco, the Miami franchise attorney who represents the Pines, says the plans of the acquiring company, who that company is, and the timing of the purchase are all-important in determining whether a franchisor is obligated to inform its franchisees and any potential franchise buyers.  Naturally, if an acquiring company plans to change the system, the franchisor has a duty to inform existing and prospective franchisees about a sale.

Is the system being sold to a company that is in competition with existing franchisees?  If so, franchisors are under greater obligation to inform existing and prospective franchisees of any acquisition negotiations.  If the acquiring company is in another field entirely, the franchisor is held to a lower standard of disclosure.

There's an extra responsibility for the franchisor to tell prospective franchisee if there's a chance the company will be acquired.  "The law imposes a higher duty to disclose to prospective franchisees the fact that the system they're about to enter is going to change," says Zarco.  The reasoning behind this is that existing franchisees are already an established part of the system, whereas the sale of the franchise company would certainly affect a prospective franchisee's decision whether to join the system.

Only one set of circumstances reduces the requirement that a franchisor tell its franchisees about a sale: if the acquiring company doesn't plan to change anything about the system. "The requirement of disclosure," says Zarco, "is directly correlated to the effect the transaction will have on the existing franchisees."

Pick A Card, Any Card

The options Clucker's gave the Pines are typical of those offered to franchisees after an acquisition: keep the franchise name but forfeit the franchisors' support, operate an independent business, or covert to another franchise name and format.  However, some franchise experts admit there are times when all theses choices may look unattractive.  According to Zarco, the options franchisees are routinely given in this situation are "like putting a loaded gun to the temple of the Franchisee.  It is highly unfeasible to remain an independent bearing the franchise's name when you don't have a [franchisor] anymore."

If the Pines had remained a Clucker's Oak Roasted Chicken restaurants, they would have been running the only Clucker's in existence.  "We wanted to be part of a chain---a franchise," says Beth Pine.  "To us, the name didn't mean anything unless it was going to be expanded."  The Pines thought holding on to the Clucker's name would be futile if they had to give up their franchisor's support.

Running an independent business, Zarco says, is not much of a solution either.  If the Pines had wanted to open their own chicken restaurant, they would have.  Instead, they chose to open a franchise---at a much greater cost.  "We could have opened a mom and pop chicken place for $50,000," says Pine.  This is in stark contrast to the $400,000 they spent readying their Clucker's franchise for its debut.  But if they'd chosen to run an independent restaurant, the Pines feared they wouldn't garner the recognition they enjoyed as a part of a well-known franchise system.

Converting an existing franchise to another franchise format has its share of complications, too.  For one thing, it can be expensive.  Miami franchise attorney Kenneth Darrow says financial arrangements in this type of situation run the gamut form the franchisor paying all conversion costs to the franchisee footing the bill to something in between.  In this case, the Pines would have had to shoulder the entire burden of conversion.  "We were into this thing to a point where we weren't going to risk any more of our own money," says Beth Pine.

Aside from the financial hardship converting to a new format sometimes entails, there is also the possibility that the acquiring company has already sold the rights to a territory to one of its own franchisees.  The Pines' situation is a case in point: "Our protected territory [as a Clucker's franchisee] was owned by a Kenny Rogers Roasters franchisee," says Pine.  In other words, as a Clucker's franchisee, the Pines claimed the rights to a certain geographical area; but if they'd converted to a Kenny Rogers Roasters, they would have been competing with another Roasters franchise for the same territory.

Occasionally, franchisees whose franchisor is acquired receive yet another option, and sometimes it's the best thing that can happen to them: The franchisor offers to buy them out.  Darrow says one of his former clients had a franchisee in this position, and though his business was doing well, he wanted to move across the county, so he took the offer.

Getting Involved

Is there anything prospective franchisees can do to find out if a franchisors is about to be acquired before they take the plunge and purchase a unit?  Zarco says your best defense is asking the franchisor certain questions before buying into a system.  A sampling of queries a prospective franchisee should ask: Are you going to operate them out of the same home office?  Is the training going to be provided by the same people? Will you disclose marketing strategies and secrets to the other company?

Not all acquisitions lead to dilemmas like the one the Pines found themselves facing.  But for an acquisition to be successful, franchise attorneys seem to agree on one thing.  Says Darrow, "The acquiring company needs to build goodwill with the franchisees of the acquired company to continue a good business relationship."