Friday, March 18, 2016

Franchise Valuation through Damage Analysis

Recently I was invited to co-present at this year's upcoming American Bar Association's Annual Forum on Franchising (it is not until November but we get an early start on the materials that go into it). The general topic: monetary damages in franchise disputes; it got me thinking about my last post (How much is that franchise business worth?)

Why? Well many franchise disputes focus on the termination of the relationship and the damages to which one of the parties may be entitled. Central to this analysis is the value of the loss. But the real question is: which party is suffering the loss, the franchisor or the franchisee? Now this is a complicated area and far too complex to do justice here, but let's just touch on few damage remedies that may, when carried over to the "worth" of franchise, offer some guideposts.

Franchisor Recovery - Lost Profits - Lost Future Royalties: Although case law in this area is not completely settled, when there is a premature termination of a franchise agreement (not the full term), many franchisors seek the balance of the royalty payments due to the end of the contracted term as damages. A number of courts have permitted recovery of these "lost future royalties," especially when the franchisee abandons operation and simply closes. Some courts permit this recovery upon any "material" breach by the franchisee (i.e. failing to pay royalties). In this instance, from the franchisor's perspective, the worth of the franchise is the total amount of royalties to be paid. However, some courts have denied this type of recovery or have limited it, depending on whether the franchisor actually brought about the termination (instead of just suing for the past due royalties) or has not deducted its own service costs during the balance of the term.

Franchisee Recovery - Lost Profits or Fair Market Value: When a franchisee is wrongfully terminated, two approaches may be available: Lost Profits and Fair Market Value. In the most simplistic terms, future Lost Profits for a franchisee is the reasonable amount of profit (revenue less all expenses) the franchisee could expect to earn over the balance of the term based on reliable PAST sales and expenses date; while Fair Market Value is more complicated to calculate, think of it as "market" value - what would an arm's length buyer be willing to pay and a reasonable seller willing to take? Courts have approved both methods when solid evidence is presented. But franchisees cannot recover both and must elect one approach or the other.

So, as you can see, the "value or worth" of a franchised business may be in the eye of the beholder! But keep in mind that there are many NUANCES involved in these approaches - we can't cover them all here - and franchise owners and franchisors need to heed the advice found in the last post (How much is that franchise business worth?)

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