What Franchisors Need to Know About Tax Planning Before a Sale

As the franchise space continues to see strong M&A activity, odds are the leadership team has discussed whether now is the right time to sell. But just as important as valuation to understand how much the business is worth, franchisors on the sell side also need to think carefully about what a transaction could mean from a tax perspective. This starts with tax planning well before a deal is inked.

Tax planning considerations

Franchisors must understand their tax structure, identify potential risks, and evaluate the tax implications of different deal structures to help them enter negotiations with more leverage. Here are five top tax planning considerations for franchisors considering an exit: Evaluate legal entity structure and tax basis Franchisors should start by understanding exactly what they are selling and how it's currently taxed. Is the business taxed as a partnership, corporation, or S corporation?

Where is the tax basis – the amount the IRS considers as your investment in the business? Is it in the company's assets, its stock, or partnership interests? These factors can significantly influence the tax consequences of a transaction and may help determine whether an asset sale, equity sale, or another structure makes the most sense.

This analysis should happen before going deep into negotiations. The earlier people understand their options, the better they are positioned to evaluate the tradeoffs. Understand the “step up” strategy A “step up” increases the tax basis of the assets acquired by the buyer, potentially allowing the buyer to claim additional depreciation or amortization deductions.

For franchise businesses, where much of the value may be tied to franchise agreements and intellectual property, those deductions can often be taken over a 15-year period, reducing the buyer's future cash tax burden. That tax benefit can have real value to a buyer, and potentially create an opportunity for a seller to negotiate a higher purchase price. But a structure that provides a buyer with a step-up could also create additional tax for the seller.

Historical tax risks

Sellers should quantify both sides of the equation before agreeing to a structure, and use that analysis as a negotiating tool. Assess historical tax risks Before entering a sales process, franchisors should examine their historical tax compliance. For franchisors with franchisees operating across multiple states, that may include determining whether income tax returns should have been filed in each state where the business has a tax presence.

Sales tax also deserves attention. While franchisors don't typically have broad sales tax obligations, certain offerings such as software or access to franchisee dashboards could be treated as taxable software-as-a-service in some states. Identifying these issues before a buyer's diligence process gives an opportunity to address them proactively.

Estate planning strategies

Otherwise, an issue uncovered during diligence could become a negotiation point or affect the purchase price. Factor in estate planning Not every franchise founder plans to walk away from the business entirely. Some may roll over a portion of their equity, remain involved, or continue to participate in the company after the transaction.

That makes it important to consider the long-term plans early in the process. Depending on the circumstances, trusts and other estate-planning strategies may help manage gift or estate tax and facilitate the transfer of wealth to the next generation of the family. These strategies often require time to implement, so waiting until a transaction is already underway can limit the options.

Avoid this common transaction mistake: It’s all about timing One of the most common mistakes sellers make is failing to understand what they're selling until they're already in the middle of a transaction. By then, key decisions about structure, tax risk, and potential step-up opportunities may already be on the table. The best time to engage with a tax and transaction advisory team is generally when beginning to evaluate an exit and working with an investment banker, not after buyers are already at the negotiating table.

Ideally, this is 12 to 24 months before a sale, allowing time to clean financials, resolve compliance issues, and implement strategies that improve earnings and valuation. Franchisors don't necessarily need to complete every analysis before deciding to go to market, but having a clear view of the tax structure, risks, and value-creation opportunities can help negotiate from a position of strength. Tax planning may not be the first thing on a franchisor's mind when considering a sale.

But the earlier they understand the tax implications of their options, the better prepared they will be to make informed decisions, maximize value, and avoid surprises when it's time to close. *Matt Taylor is a partner in the tax transaction advisory services practice at Bennett Thrasher.