Lao Tzu, the ancient Chinese philosopher, said, “A journey of a thousand miles must begin with a single step.” For Dunkin’ Donuts franchise owners, that first step began with the acquisition of their first shop. Whether that journey ends with the death of the franchisee, or continues into the next generation, rests largely with the path he or she chooses—will it be clearly spelled out in legal documents, or will it be up to his survivors and the courts to rule?
Dunkin’ Donuts franchise owners face certain restrictions and obstacles in their succession plans. The brand’s Franchise Agreement contains specific language regarding transfers during the franchisee’s life, upon the eventual sale of the franchise and upon the franchisee’s death. These restrictions make it imperative the franchisee create a succession plan that is clearly mapped out well in advance.
The Franchise Agreement also restricts what type of entity may own the shares in the business. In recent years, Dunkin’ Brands permitted a franchisee to transfer their corporate shares to a qualified Dunkin’ Donuts Franchise Trust (DDFT), an instrument with limited purpose and very specific terms. It must be approved by Dunkin’ Brands before any transfers of stock are made to the DDFT. Failure to follow the requirement imposed by Dunkin’ Brands can trigger a default under the Franchise Agreement.
The battle plan
It is imperative for the franchisee to lay out the key aspects of his/her succession plan—the battle plan, if you will. This includes when and how the business will be transferred, to whom it will be transferred and whether there are any obstacles to making the transfer. The franchisee should consult his/her accountant, business advisor, attorney, and insurance agent when making these decisions.
After identifying a successor, the team should determine whether or not
the business should pass at the time of the franchisee’s death or during his/her lifetime. If the business is going to pass at death, the team should determine what steps are necessary to create a transition to the next generation and what attributes the purchaser should have.
Preparing the next generation
If a franchise owner is considering passing the business to his/her children, these questions should first be addressed: 1) What is the level of education they need? 2) Should they work in other franchise businesses before joining the family business? 3) Is there any impediment which might prevent the child from taking over the business?
Once these questions are addressed, the franchise owner can help facilitate the paperwork necessary to designate the child a qualified franchisee.
Another important consideration is how to equalize the balance of the estate for those family members who are not going to become qualified franchisees. Many Dunkin’ Donuts franchise owners own the real estate on which their shops sit. Some franchisees choose to equalize their estate by passing the operating businesses to one child and the real estate holdings to another. While this move creates equity on paper, it can present real-life challenges by potentially creating competing interests for each child.
Consider the troubles that could arise when the next-generation franchisee is at the mercy of his/her sibling who owns the real estate. That child can determine rent and lease terms which create uncertainty in the business plan. Furthermore, the next-generation franchisee may at some point decide to relocate the business to a location he/she purchases or controls, thus leaving the sibling’s property without a tenant but with continuing expenses. Issues such as these must be addressed in the estate plan.
Avoiding tax penalties
A franchisee’s succession plan cannot consist of just wills and trusts. Additional documents which specifically deal with the day-to-day operation and transition of the business must also be drafted. Typically, an operating business will have in place a shareholders’ agreement or an operating agreement, if the entity is designated a limited liability company. These agreements can outline the life events that will trigger transfers for the franchise owner, opportunities for the franchise owner to retire, or for the business to continue or be sold.
If the franchise owner is looking to retire and pass the interest to a family member, additional complications are present. He/she has to decide whether the sale of the business to the younger generation will be for full fair market value, as a gift, or as a combination of the two. The decision can affect the income needs of the retiring franchisee as well as state and federal estate and gift taxes.
U.S. tax laws say an individual may transfer assets worth up to $5.34 million to a person of their choice; a married couple can transfer twice as much without triggering the estate tax. If the value of assets is higher, the government will impose an estate tax of approximately 40 percent of that excess amount. Careful weight must be given to determining the value of the business so the plan can ensure the transfer does not warrant excessive tax payments whether the transfer takes place during the owner’s lifetime or upon his/her death.
According to the International Franchise Association (IFA) only 30 percent of franchise businesses continue to the second generation, and only 12 percent survive into the third generation. In most cases it’s because the franchisee failed to properly plan. Franchisees work hard to build their business and accumulate wealth; how and to whom that success is transferred is your choice. An estate plan that is well-constructed and frequently reviewed, ensures your wishes are followed.
Seth Ellis is a Director with the law firm Tripp Scott, P.A. with core focus areas in estate planning and asset protection for entrepreneurial clients.