Buying an Existing Franchise: Checking Debts and Liabilities

An attractive purchase price can conceal costly obligations. Before joining a franchise network by buying an existing outlet, you need to understand which debts will remain with the seller, which will stay with the business you acquire, and how to protect yourself against liabilities discovered after the sale. This assessment starts with one question: what exactly are you buying?

1. Distinguish between an asset purchase and a share purchase

Buying a business’s operating assets and goodwill — known in France as a fonds de commerce — carries different risks from buying shares in a company. Do not rely solely on an advert’s description of a “franchise resale”.

In a share purchase, you become a shareholder in the company operating the outlet. The legal entity remains unchanged: its debts, contracts and the consequences of its past activities remain with it. A tax liability uncovered after completion can therefore reduce the value of your investment, even if it relates to an earlier period.

When buying a fonds de commerce, the seller’s debts do not, in principle, automatically transfer to the buyer. That does not make the transaction risk-free: particular rules apply to certain contracts, some obligations may be expressly assumed, and statutory provisions, particularly those relating to tax, may affect the buyer. Payment of the purchase price must also comply with formalities designed to protect creditors.

Ask your lawyer for a written explanation of what you are acquiring, which obligations will transfer and which formalities must be completed. Clarify these points before making a binding offer.

2. Establish the full liabilities beyond the latest balance sheet

A balance sheet is a snapshot at a particular date, not a guarantee that there are no problems. Ask your accountant to reconcile the annual accounts with up-to-date management accounts and supporting documents.

The due diligence file should include:

• a detailed list of supplier debts, including due dates and disputed invoices;
• loans, overdrafts, finance leases and repayment schedules;
• tax and social security returns, proof of payment and correspondence relating to any inspections or investigations;
• shareholder loan accounts and their repayment terms;
• disputes, customer claims and warranty obligations;
• guarantees and other commitments given by the company.

An amount recorded in the accounts is not necessarily payable immediately; an obligation left unrecorded can still prove costly. Assess the nature of each item rather than simply adding up the balances.

Also examine customer deposits, prepaid services, credit notes and gift cards that remain valid. These may require the business to provide services after you take over, even though the money has already been received. The transaction documents should explicitly state how these items will be treated.

3. Identify amounts owed to the franchise network

A franchised business may have obligations to the franchisor that are separate from its ordinary bank and trade debts. Check outstanding royalties, advertising contributions, IT subscriptions and invoices issued by companies connected to the network.

With the seller’s consent, ask the relevant parties for a written reconciliation of outstanding balances. Look in particular for deferred payments, temporary discounts and any adjustments that have been announced. Do not assume that a concession granted specifically to the seller will continue for your benefit.

In France, pre-contractual disclosure requirements are based notably on Article L. 330-3 of the Commercial Code, introduced by the Doubin Law of 31 December 1989, and Article R. 330-1. Where the statutory conditions are met — making a brand, trade name or trading sign available in return for an exclusive or near-exclusive commitment — the pre-contractual disclosure document and draft agreement must be supplied at least twenty days before signing or making any required advance payment.

This information about the network does not replace due diligence on the liabilities of the business being sold. The sale agreement is also subject to the general rules governing sales and contracts.

4. Turn your findings into written protections

Once due diligence is complete, classify the risks: a confirmed debt to be settled, an amount to be reflected in the price, an uncertainty requiring protection, or an obstacle that justifies putting the transaction on hold.

For a share purchase, a French asset and liability warranty agreement, known as a garantie d’actif et de passif, can provide compensation for the buyer if a liability originating before the sale comes to light afterwards. This protection is neither automatic nor standardised. Have the covered events, exclusions, financial caps, time limits and claims procedure clearly defined.

The financial standing of the party providing the protection matters as much as the wording. Depending on what is negotiated, retaining part of the purchase price, placing funds in escrow or obtaining a bank guarantee may strengthen your protection. Also agree how changes between due diligence and completion will be monitored.

Key takeaway: before signing, obtain a schedule of verified debts, how they are reflected in the price and the protections agreed. Every significant risk needs a written response, not merely a verbal assurance.