New Guidance on How to Determine Franchise Buyout Price in the United States

Business deals do not always go as planned. In some cases, one party may decide they are no longer interested in a deal. When this happens, all the parties involved in the business deal must determine how to buy out the uninterested partner.

Is there a guideline to follow to help one know how to determine the buyout price in the United States? As of July 2023, a recent case created new guidelines for determining franchise buyouts. This article will explore the third circuit’s new guidance on determining a franchise buyout.

Guidance provided by the Third Circuit

Sapp v. Indus. Action Servs., LLC, No 22-2181 was a prominent 2023 case in this subject. In this case, the parties agreed that sellers could earn additional consideration after closing an asset purchase agreement. However, that was only possible if they met certain post-closing EBITDA benchmarks – also known as the “Earnout.”

The earnout consideration could go as high as five million dollars for each trailing year, amounting to $15 million. To do this, the company’s accounting firm must first issue an earnout statement, after which all parties have 60 days to meet and resolve. Also, within said days, parties will review work papers and have a national independent accounting firm resolve arising issues in the Notice of Determination.

For example, when there is disagreement among parties, the accounting firm addresses the disagreement and determines what constitutes definitive calculation. Also, an allowance allows for judgment to be entered in any competent United States” court.

It is important to mention that the language of the judgment provision shares some similarities with what is obtained in arbitration provisions. However, the contract posed a dispute resolution clause where parties must seek mediation and resolution for disputes under the contract.

The EBITDA Statement

The EBITDA statement represents a company’s earnings before income, taxes, depreciation, and amortization. According to the EBITDA statement, no earnout was due, leading sellers to claim that the company wrongfully acted to circumvent proper accounting. In this case, a motion was duly filed by the buyer, praying the court to order the appointment of an independent national firm for the calculation of arbitration. Unfortunately, this motion was rejected by the federal magistrate.

The district court granted the request and ordered the appointment of an independent national accounting firm for arbitration award. The award confirmed the earlier assertion that no earnout was due, after which sellers moved to vacate the award but were denied.

Appeal to the Third Circuit

The sellers appealed to the Third Circuit, which the panel reversed and remanded, determining that contractual limitations narrowed the authority and inquiry scope. Also, the Third Circuit determined that the earnout calculation was not an arbitration using four factors:

1. The scope of authority provided by the company’s work papers was typical of expert accounting
2. The accounting firm should complete the determination within 30 days
3. The provision did not contain rules of procedure to ensure due process and
4. The imposition of arbitration is inconsistent with the dispute resolution elsewhere in the agreement

“Undoubtedly, it is essential for anyone who wants to determine a franchise buyout price in the United States to pay attention to the new guidelines to reduce the margin of error,” says Attorney Jason W. Power of Franchise.Law.