Buying an Existing Franchise: Structuring an Earn-out

The seller values the business’s potential; you would rather pay for proven results. When buying an existing franchise, an earn-out can help reconcile these positions. Part of the price is then linked to future performance. However, this arrangement requires careful drafting: it should neither make the acquisition cost unpredictable nor restrict your ability to run the business.

1. Distinguish an earn-out from deferred payment

An earn-out provides for an initial price and an additional sum calculated using agreed criteria. That sum might depend, for example, on profits achieved after the acquisition. It may be zero if the agreed conditions are not met.

Seller financing works differently: the seller agrees to receive part of an already fixed price at a later date. Deferring a fixed debt is not the same as making part of the price conditional on performance. Both arrangements can be used together, but they must remain clearly separate in the transaction documents.

Before negotiating, identify what justifies the earn-out: recent growth with a limited track record, a customer base still being established, or orders whose profitability has yet to be confirmed. If the disagreement simply concerns incomplete accounts, start by obtaining the missing documents. A conditional formula is no substitute for due diligence.

Finally, ask your lawyer to tailor the arrangement to what you are acquiring: the business and its operating assets (known in France as a fonds de commerce) or shares in the company. The legal, accounting and tax implications differ.

2. Choose a measure both parties can verify

A formula based solely on turnover may seem simple, but it can reward sales with poor margins. A profit-based measure better reflects financial performance, although it is more sensitive to management decisions and accounting policies.

With your accountant, specify in particular:

• the scope: the acquired outlet, the activities included and the sales channels covered;
• the measurement period and how any partial financial year will be treated;
• the accounting data to be used and when it will be available;
• permitted adjustments, particularly for exceptional expenses;
• the trigger threshold, calculation formula and earn-out cap.

For a franchise, pay particular attention to the treatment of royalties, advertising expenditure and costs associated with the network’s systems and tools. A new agreement may change these costs compared with those borne by the seller. Comparing two sets of results without adjusting for that difference could distort the calculation.

Include worked numerical examples in the negotiation documents, covering low, expected and high performance. These examples are not forecasts: they are there to check that the formula works as intended, particularly close to the trigger threshold.

3. Align the clause with the French franchise framework

The earn-out is negotiated with the seller, but future operations also depend on the franchise agreement. The franchisor is not automatically a party to the sale and does not guarantee the performance used to calculate the earn-out.

In France, franchising is governed in particular by general contract law and specific pre-contractual disclosure requirements. Article L. 330-3 of the French Commercial Code, introduced by the Doubin Law, applies where a party makes a trade mark, trade name or trading identity available while requiring exclusive or near-exclusive business activity. Article R. 330-1 specifies the contents of the pre-contractual disclosure document.

Where these conditions are met, the disclosure document, known as the DIP, and the draft agreement must be provided at least twenty days before the relevant agreement is signed or, where applicable, before any required advance payment is made. This period does not create a general right to withdraw after signing.

Have this timetable coordinated with the acquisition schedule. Before finalising the earn-out formula, you need to know the operating terms that will apply to you as the buyer. A change in the network’s requirements may directly affect the chosen performance measure.

4. Plan for payment and disputes from the outset

Specify who prepares the calculation, which supporting documents are sent to the seller and how long the seller has to comment. Their access to information should be limited to what is necessary, with appropriate confidentiality obligations.

The clause should also address disruptive events: temporary closure, a change in business activity, resale or a significant change in accounting policies. Do not accept a blanket obligation to retain all the seller’s practices if it prevents you from running the business normally.

For technical disagreements, your lawyer can provide for an independent third party to intervene, defining their remit, how they are appointed and how their fees are shared. Also specify the payment due date and how any undisputed amount will be handled.

Finally, include the maximum earn-out in your financing plan and its payment date in your cash-flow budget. A conditional price still represents a potential cash outflow.

Key takeaway: do not sign without a verifiable formula, an explicit cap and worked examples. Have the price clause and the future franchise agreement reviewed together.