Dunkin’ operator swaps Northeast stores for sunshine state
Franchisors all sold out in one region but expanding in another may consider the swaps.
A 1031 asset exchange works for franchises, too. The tool fueled a $37-million transaction and gave a land-locked franchisee room to expand. The drawback? “He had a big payday without the payday.”
By now, Tim Cloe is operating his newly purchased 22 Dunkin’ Donuts stores plus development rights in Orlando, a wide-open market for the brand and home to all that sunshine. That’s after selling 13 stores in Massachusetts, where the franchise system began and where locations for new stores are hard to come by.
And he completed the $37-million transaction without a big tax bill.
That’s because Cloe’s deal used a financial tool called the 1031 asset exchange, in which assets are sold and the proceeds parked in an escrow account, with 45 days to identify replacement property of a similar type to purchase and then 180 days to close.
A common tool used when buying and selling real estate, the vehicle works for franchises, too, which few people know. “If it’s in compliance with IRS guidelines you can do it with wine, cars—but more apropos, franchises,” says David Paris, the Paris, Ackerman & Schmierer partner who with his colleague Mike Ackerman handled legal work on the complex deal.
They likely earned their fees. “It’s the biggest aggregate transaction our firm has undertaken,” he says, and multi-unit acquisitions always come with multiple entities, leases and landlords. “But here you have the added pressure—and it’s significant pressure—to meet the timelines imposed by 1031.
“It gives the selling party a little more leverage to screw with you, or take advantage of you, or get themselves a better bargain, because they know a gun is against your head,” Paris says.
An added complication: the Dunkin’ process usually calls for a 60-day right of first refusal when any stores come up for sale—too long to meet IRS requirements.
“Because of our client’s reputation in the system, I won’t say they short-circuited the system, but they were eager” to green-light the deal quickly, Paris says. He is talking with other franchise systems about how to do 1031 asset exchanges and presenting seminars on the topic, to keen interest.
Dan Connelly, managing director at JCM Franchise Development in Plymouth, Massachusetts, is the architect of the deal. “Tim’s an aggressive franchisee. He’s a shining star in the Dunkin’ community. And he made a family and geographical decision to move to Florida,” Connelly says. Cloe himself didn’t want to talk about the swap.
Cloe’s original desire—to sell his 13 stores in Massachusetts—was easy to fulfill, Connelly says. “Stores just don’t come for sale very often, given they’re so valuable. A lot of second- and third-generation families have kept the stores as a thriving business.”
But Connelly and his colleagues encouraged Cloe to think bigger. Still in his 40s, still eager to grow, and with a sophisticated finance background honed on Wall Street, Cloe was a perfect candidate for a 1031. “It’s a great way to keep growing and use the tax code to advantage,” Connelly says.
The requirements are strict, which is why Connelly enlisted Citibank experts and Paris Ackerman attorneys. Sal and Salvi Couto, Dunkin’ franchisees now with more than 60 stores in Massachusetts, bought Cloe’s 13 stores, near Dartmouth. Those proceeds are held in a qualified intermediary escrow account, with 45 days to identify the replacement property.
That property must be “like-kind” to the sold property. In this case, selling Dunkin’ stores and buying Dunkin’ stores obviously fits the bill, but there’s more leeway than that. For example, selling a Dunkin’ store and buying a different brand but still in the quick-service restaurant space would likely pass muster, Paris says.
Then the buyer has 180 days to close on the replacement assets, which can get hairy. JCM identified five stores owned by one seller for Cloe to buy in Orlando, which was relatively simple. Then a seller with 17 stores came up, plus some development rights, which tapped out the rest of the original sales proceeds plus required more capital secured from a bank.
“There’s a leap of faith involved, buying and selling at the same time,” Connelly says. If a seller declares replacement assets and for “whatever reason that doesn’t happen, then you have a taxable event.”
Connelly is promoting more such transactions, especially for brands that may be maxed out in one region of the country but looking to grow somewhere else, and for operators keen to expand in greener—or sunnier—pastures. Dunkin’, for example, has 673 locations in Florida and 1,143 in Massachusetts.
He cautions that to work well, legal counsel at the franchisor must be on board, as he says they were at Dunkin’, to make the timelines. “We’re under contract with some that will hope to replicate the same process,” he says.
There is one drawback to 1031 asset exchanges, which hold and then re-deploy proceeds from a transaction. Business owners don’t get to celebrate their “liquidity event,” that glorious day when the cash hits the bank account. “He had a big payday but without the payday,” Connelly points out about Cloe.
But the dealmakers took time to toast the transaction, anyway. “We had a very nice closing dinner, took the client out to celebrate in Boston and woke up with a hangover,” Paris says.