Buying an existing franchise: check for hidden company debts

Buying an established franchise outlet can be an attractive way to join a franchise network: the outlet is already trading, customers know it and its revenue can be verified. But if you are buying a stake in the company, you are not just buying its future business. The company also retains its existing liabilities. Your pre-purchase due diligence therefore needs to answer a specific question: which past decisions will you end up funding after the takeover?

1. First, clarify exactly what you are buying

The phrase ‘franchise for sale’ is not precise enough. The seller may be offering a stake in the company that operates the outlet, or individual assets, stock and equipment. This guide focuses primarily on buying a stake in an existing limited liability company.

In this type of purchase, the company remains the same legal entity. Its tax debts, amounts owed to suppliers and other liabilities do not disappear when its ownership changes. As a rule, ownership alone does not make the buyer personally liable for all the company’s debts, but those debts affect the value of the investment and may require additional funding.

Before agreeing a price, ask for a clear definition of what you are buying. Check the company’s registered name and registration number, ownership of the stake and any encumbrances over it. Also make sure that this is the company named as a party to the franchise agreement, lease and key supplier contracts.

Buying individual assets is not automatically a risk-free alternative. Specific rules may apply to the transfer of certain liabilities, so ask legal and tax advisers to compare the two options.

2. Review liabilities, not just reported profits

The annual report is a starting point, not conclusive evidence. Request up-to-date accounting records and supporting documents so that an accountant can verify the position at an agreed cut-off date. Pay particular attention to liabilities that are not yet due or whose amount has not yet been finalised.

The review should cover:

• Taxes: filed tax returns, a tax clearance certificate, and details of ongoing tax audits and disputed tax treatments.
• Suppliers: a list of outstanding balances and their due dates, payment reminders, instalment agreements and disputed invoices.
• Financing: loan and leasing agreements, security arrangements, guarantees given by the company and shareholder loans.
• Customer obligations: unredeemed vouchers, advance payments received, complaints and obligations arising from service packages already sold.
• Disputes: court cases, enforcement proceedings and written claims that have not yet led to formal proceedings.

A tax clearance certificate does not, on its own, guarantee that a subsequent audit will not identify additional liabilities for an earlier period. Equally, the absence of court proceedings does not mean there are no outstanding claims.

Pay particular attention to transactions with the seller and related parties. If a shareholder has lent money to the company, selling their stake does not mean they have waived repayment of the loan. The agreement must make clear whether the debt will be repaid, assigned or otherwise dealt with.

3. Check debts within the franchise relationship

For a franchise company, a general financial review is not enough. Unpaid franchise fees or other breaches may put the agreement on which the outlet’s business depends at risk.

With the seller’s consent, obtain written confirmation from the franchisor of any outstanding amounts. Compare this with the company’s records. Also ask whether any reviews of fee calculations are under way that could result in additional payments for earlier periods, and whether there are any unresolved claims for breach of contract.

A change of shareholder does not necessarily leave the franchise agreement unaffected. Check its change-of-control provisions: the agreement may require the franchisor’s prior consent. If consent is required, make obtaining it a condition of completion, rather than relying solely on the seller’s promise.

Slovenia has no dedicated franchising law, mandatory franchise-specific pre-contractual disclosure document or franchise register. Contractual relationships are governed by the general rules of the Slovenian Obligations Code, while the company and the transfer of an ownership stake are governed by the Companies Act. Relevant tax and other legislation must also be taken into account. Transferring a stake in a Slovenian limited liability company (d. o. o.) requires the prescribed notarial form. The absence of franchise-specific rules is therefore no reason to carry out less thorough due diligence.

4. Reflect your findings in the sale and purchase agreement

A list of risks is useful only if it influences the terms of the purchase. Work with your lawyer to agree seller warranties confirming that all liabilities have been disclosed, together with specific indemnities for identifiable pre-completion risks, such as an ongoing tax audit.

The agreement should clearly set out the claims procedure, time limits, any limits on liability and the evidence required. Consider retaining part of the purchase price or obtaining other appropriate security. A promise of reimbursement is worth less if the seller later has no assets with which to pay.

Also agree how the purchase price will be adjusted to reflect the actual debt, cash and working capital position at completion. Recheck key items before completion and restrict unusual payments to the seller between signing and completion.

Practical takeaway: before buying a stake, draw up a list of all known and potential liabilities. For each one, identify the supporting evidence, its effect on the price and the contractual protection needed. An established franchise is a sound starting point only if you also understand its financial history.