When venturing into the world of franchising, many entrepreneurs overlook one critical detail: the structure in which they initially purchase their franchise. It’s common for individuals to buy a franchise in their own name, instead of doing so through a Limited Liability Company (LLC). Buying a franchise in your individual capacity can lead to a host of legal, financial, and operational complications. In this article, we will explore why buying a franchise in your individual capacity and then transferring ownership to an LLC can be a costly and complex misstep. For more information on our franchise law practice click here.
The Pitfalls
Franchise Agreements and Transfer Restrictions. Most franchise agreements come with strict transfer clauses. These clauses require strict adherence and can make it difficult to transfer ownership of the franchise from an individual person to an LLC without the franchisor’s involvement, and even risking termination of the agreement if not strictly followed. A transfer to an LLC might require you to go through the approval process all over again, including paying additional fees. When in doubt, follow the simplest path and that is, unequivocally, buying the franchise in the name of the LLC. Why add an extra step?
Loss of Liability Protection. One of the main reasons entrepreneurs choose to operate under an LLC is to protect their personal assets. Your personal assets include everything from your home to your child’s college savings. However, if you start off as an individual owner, your personal assets might be exposed during the time you own the franchise in your name. The primary purpose of an LLC is to protect your individual self, including your personal assets. Yet these protections are not afforded when buying a franchise in your individual name. Even after transferring ownership to an LLC, any legal issues that arise during the period of individual ownership could still implicate your personal assets, defeating the purpose of having an LLC. Additionally, the connection between your franchise business and your individual self will always exist, even after subsequently transferring ownership to your LLC. A savvy plaintiff’s attorney will likely include you – individually – as a defendant in a lawsuit against your franchise business, along with your LLC.
No Value Added. Practically, there is no benefit to buying your franchise in your individual name. Why would anyone buy a franchise in their individual name? Generally it is in response to pressure from the franchisor. Franchisors may encourage people to buy their franchise in their individual names to get the sale finalized. If there is no upside, then why do it?
Lasting Personal Liability. You will remain personally liable to the franchisor even after transferring ownership to your LLC. This is one of the primary reasons why franchisors encourage it! After a transfer of ownership, franchisors have the benefit of going after two different parties: you, personally, and your LLC!
In conclusion, a transfer only benefits the franchisor and offers no upside to the franchisee!
A. Form Your LLC First. Before signing any franchise agreements, it is crucial to form your LLC.
B. Buy Your Franchise in the Name of Your LLC. This ensures that your franchise is owned by the LLC from the start, helping to protect your personal assets. Even if your franchise agreement requires a personal guarantee, that only benefits the franchisor and thus you are protecting your personal assets from the rest of the third-party universe!
Conclusion
While it might seem like a small detail, the entity under which you purchase a franchise can have far-reaching consequences. By buying a franchise in your individual capacity and then attempting to transfer ownership to an LLC, you expose yourself to unnecessary legal and financial risks. The smarter approach is to establish your LLC first and then purchase the franchise under that entity, promoting a smoother, safer, and more profitable business journey.
Avoid the pitfalls— and plan ahead, seek professional advice, and set your franchise up for success from the very beginning!
Craig Morgan is a franchise law, business and contracts attorney and a partner at Morgan & Forb, PLLC. Headquartered in Charlotte, NC, our firm is licensed in North Carolina and Ohio. We serve franchise clients nationwide.
Our process begins with an initial consultation, which we offer at no cost to you. Click here to fill out the short form providing the basic information needed to begin and we will be in touch. We look forward to speaking with you!
Comentarios