| “Investing
in a Franchise Business” |
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KM Outlook
- Observations From an Industry Leader |
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For a variety
of well-documented reasons, including fewer senior debt
sources, tighter underwriting of senior debt financing,
more supportable purchase price multiples and an improving
economy, now is a great time to make a private equity
or mezzanine investment in a multi-unit franchise business.
At Krass Monroe, we have the experience, industry expertise
and networks to help you take advantage of opportunities
in the current market environment.
Before investing, however,
it is important to understand some of the unique issues
involved in a franchise business. Through this and subsequent
KM Outlook articles, we will address many of these unique
issues to give you a better understanding of the various
relationships involved and how you as a private equity
investor or mezzanine lender can structure your investment
in the most advantageous manner. The first unique relationship
to address is the relationship between the investor
and the franchisor.
INTERCREDITOR AGREEMENTS
It is common
for a private equity investment in a franchise business
to be structured, at least in part, as subordinated
debt financing. While many equity investors or mezzanine
lenders take common stock, preferred stock or warrant
positions in the target company, they frequently look
to structure at least a portion of the investment as subordinated
debt financing in order to provide for some degree of
collateral security through a subordinated lien on the
company’s assets. In this
scenario, it is important for the investor to have an agreement,
commonly called an “Intercreditor Agreement”,
with the senior lender in order to provide for the relative
rights and obligations of the two lenders in the event
of a default by the borrower on either the senior loan
or the subordinated loan. This type of Intercreditor Agreement
typically provides for mutual notices of default, limited
cure rights and a standstill by the subordinated lender
for some period of time while the senior lender pursues
its legal remedies against the borrower and the collateral.
INTERCREDITOR AGREEMENT WITH THE FRANCHISOR
When the
equity or mezzanine investment involves a franchise business,
the investor also needs to address its relationship with
an additional party – the franchisor. Unlike a nonfranchised
business, the franchisee has no right to operate its
business except pursuant to the franchise agreement. Therefore,
the legal relationship between the investor and the
franchisor is extremely important. It is critical to address
the relative rights and obligations of the equity investor
or mezzanine lender and the franchisor in the event
of a default by the franchisee under either the financing
documents or the franchise agreement.
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