Are You Doing The Right Due Diligence As You Grow Your System?

Fox Rothschild LLP
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In our last post, we examined some of the types of risk that come with growth. In this post, we discuss some forms of diligence that may be used to better manage that risk.

Diligence on Legal Matters

Are there operating hour ordinances that might affect the business? How about limitations on operating hours or days by the landlord? For foreign expansion, the inquiry is whether it is even legal to sell the goods and services in the foreign market. In the Middle East, not every country allows pork or alcohol products to be sold.

Tradenames and trademark protection are essential, but do you know if there are similar names or businesses already in the market that will confuse your customers? Do prior users exist which could create a threat to your brand? In foreign countries, you need to know whether the name is available for protection and whether it must be registered before selling a franchise.

Does the new territory have different rules on regulation or disclosure? Are there local laws which require disclosures, require registrations, require preapproval of advertising, or permit rescission in the absence of compliance?  U.S. franchisors probably know the national rules, or can acquaint themselves easily with local counsel to learn the rules, but going cross-border requires local knowledge. One needs to know whether the local country franchise laws require or exempt registration, or approval, prior to offering a franchise. Jurisdictions which have special franchise laws often will require mandatory disclosures, or a “quiet period” between offer and acceptance.

The local rules on termination and renewal need to be explored. Some jurisdictions require franchises to be “evergreen” such that they never expire under the law until the franchisee commit a material breach. Some jurisdictions allow termination but require buy backs from the franchisee of inventory, or some type of compensation. Some jurisdictions allow enforcement of restrictive covenants and others invalidate the restrictions as anticompetitive. In some foreign countries, preregistration of intellectual property is required, and the property reverts to the franchisee after a period of operation. Mitigation of these risks need to be baked into the deal from the outset.

Reputational Due Diligence

A frequently overlooked aspect to development is whether the addition of this geography and operator (that is, franchisee) improve the reputation of the brand. One might first start by measuring a baseline of the reputation of the brand, then examining the reputation of the folks who are intended to help you expand the brand. News sources, media and social media sites associated with the shareholders, principals and officers should be reviewed. References should be requested and should be checked. In foreign countries, that might require the use of a translator and/or local investigator. Again, care needs to be taken that even the investigator complies with local laws–including privacy laws, which can be much more restrictive than at home in the U.S.

Financial Due Diligence

In the U.S., we can rely on credit reports, criminal records searches, and electronic searches. Cross-border, data and privacy laws create barriers to common search methods used in the US. The foreign search tasks will take longer and will require more cooperation from the prospect. Foreign data is difficult to assemble and may not be as robust even when it is available.

In conclusion, expansion always requires acceptance of risk, with its many considerations such as taxes, dispute resolution, the cost of compliance and serious consideration of governing law. Expert advice should also be sought when traveling into the unknown.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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