Mastering Business Combinations: Key Tips For Franchisor Success

March 18, 2025

Navigating Business Combinations Under ASC 805

Last month, we discussed business combination tips for restaurants, highlighting key considerations when acquiring a business under GAAP. This month, we’re shifting focus to franchisors, outlining specific tips for navigating business combinations in this sector.

Adhering to GAAP standards under ASC 805 is critical for franchisors when acquiring a business, as GAAP financial statements are required for the annual FDD filing. ASC Topic 805, Business Combinations (ASC 805) provides the framework for properly accounting for business combinations, ensuring acquired assets and liabilities are recorded at fair value. Franchisors should be mindful of specialized assets common in their industry and how they are valued to ensure accurate financial reporting post-acquisition.

In this article, we’ll cover the types of assets and liabilities typically valued in franchisor acquisitions, the role of third-party valuation firms, and key timing considerations. This assumes that the transaction is an independent, arms-length acquisition, with no common control between buyer and seller.

ASC 805 (GAAP) vs. Purchase Price Allocation (Tax basis)

ASC 805 provides the framework for accounting for business combinations under GAAP, including guidance on identifying the acquirer, determining the acquisition date, and recognizing and measuring the assets acquired and liabilities assumed at fair value. The primary objective of ASC 805 is to ensure that the acquirer’s financial position is accurately and fairly presented, reflecting the impact of the acquisition on the financial statements.

A common misconception is that a company should record the assets of the acquired business based on the purchase price allocation outlined in the purchase agreement. However, the purchase price allocation is only relevant for income tax purposes and does not influence how assets are valued under GAAP reporting.

Assets Commonly Fair Valued

Under ASC 805, companies must assess the fair value of both tangible and intangible assets that are acquired. Here are some of the most common assets that will need to be fair valued during a business combination:

Assets

- Property, Plant, and Equipment (PPE): PPE is not typically material for an entity that operates only as a franchisor. If material or the franchisor re-acquired previously franchised locations, all leasehold improvements, buildings, furniture/fixtures, vehicles, and equipment should be recorded at fair value.
- Brand, Trademarks, Recipes: If the acquired franchisor holds intellectual property, it must be separately identified and valued based on its fair value, considering factors such as remaining useful life and potential future income it can generate.
- Franchise Agreements: These agreements outline the legal rights, obligations, and benefits between the franchisor and franchisee. The value of this asset is derived from the potential ongoing revenue from franchisees, including royalties, marketing/advertising, and other franchisee-related revenue streams. This intangible asset focuses on the specific contractual term outlined in the related agreements.
- Development Rights: Development rights agreements provide the franchisees with exclusive rights to develop franchises in a specific area and must be valued based on the expected future cash flows and the exclusivity of those rights. Factors such as the development timeline and the potential market for new franchisees would be considered in creating this intangible asset.
- Franchise Networks: The customer base (i.e., franchisees) represents a long-term intangible asset that is valued based on the ongoing revenue streams and the potential stability of the network post-acquisition and takes into account factors like franchisee retention, growth potential, and overall franchise system health. This asset represents a broader look at the value of the relationships with franchisees and the overall market position of the brand.
- Reacquired Franchise Rights: If a franchisor acquires one of its existing franchised locations, it should separately identify reacquired franchise rights as an intangible asset. Reacquired franchise rights reflect the company’s ability to operate and control the franchise location or territory and should be separately valued as it represents a future economic benefit to the acquirer, distinct from goodwill or other intangible assets.
- Goodwill: Goodwill arises when the purchase price exceeds the fair value of the identifiable net assets acquired. These include intangible assets like brand reputation, customer relationships, and employee know-how.

Liabilities

Deferred revenue from initial franchise fees and development agreements, gift card liabilities, and loyalty card liabilities – these acquired liabilities have historically been required to be recorded at fair value in accordance with ASC 805, which created challenges with aligning the related revenue recognition with the acquirer’s existing revenue recognition policies.

The FASB issued ASU 2021-08, Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, which is effective for fiscal years beginning after Dec. 15, 2024, to simplify the accounting for acquired contract liabilities and related contract assets (including deferred revenue related to initial franchise fees and development agreements, gift card liabilities, loyalty card liabilities) by eliminating the need to fair-value these liabilities at the acquisition date.

Stay tuned for next month when we deep dive into this new standard and discuss how it will impact future acquisition accounting.

Other GAAP Considerations

Contingent Considerations: If the deal includes contingent payments (e.g., earnouts), these need to be valued at fair value based on the expected payout, including potential earnouts tied to future performance.
- Transaction Costs: ASC 805 outlines specific guidance around what can be capitalized and what is required to be expensed related to acquisition-related expenses.
  - Capitalizable – financing costs related to obtaining debt or issuance of equity, and underwriting fees associated with debt and equity issuances.
  - Expensed – legal fees (not associated with debt or equity issuance), due diligence costs, valuation fees, finder fees, and acquisition-related bonus expenses.

In most cases, a third-party valuation expert is best practice for providing an independent and objective assessment of the fair value of acquired assets. This is critical to ensure the process is done correctly and in compliance with GAAP.

Timing Considerations

It is never too soon to start considering third-party valuation firms and potentially reaching out to discuss pricing for valuation assessments. Best practices suggest initiating these discussions within 30-45 days after closing the acquisition. These engagements can require at least 4 to 8 weeks to complete, depending on how quickly the requested items are provided.

Once the valuation is finished, it often leads to significant adjustments to your financial statements, typically involving the recording of new goodwill and intangible assets, related amortization expense, and other items identified during the valuation process. It is crucial that a company allocates sufficient time to complete these tasks promptly to avoid delaying year-end financial statement deadlines.

We also recommend a meeting amongst management, your auditors, and the valuation firm before starting the valuation process so all parties are on the same page when it comes to scope and valuation methodologies.

A company should be prepared to engage valuation experts and spend time carefully assessing the fair value of assets and liabilities upfront. This time investment is imperative to provide timely and accurate financial reporting, which allows the FDD filing to occur on time and allows the company to continue selling franchises.

Our GBQ valuation team can guide you through the business combination process. Whether you have a question about GAAP guidance for our assurance team or a question about valuation, we have a team of experts to help you. Contact us today.

By Kari Maue, CPA, Director, Assurance & Business Advisory Services