If you’ve got a great product or a great idea and decide you should be franchising it, there’s a lot to be done before you set off down that path.
The first step is to make sure that your proposed business activity lends itself to franchising and can be easily replicated by your prospective franchisees. This is best done by documenting your business processes to ensure that they can easily be followed by the franchisees you eventually appoint. You also need to ensure that you will have enough initial and working capital to get the business to the point where it can be franchised.
The people you’ll be hoping to attract as franchisees will want to know a great deal about your plans and aspirations. They may be impressed by your enthusiasm and your grand idea but they’ll also want to know the nitty gritty. Getting them - and perhaps your lending institution - enthused will require a business plan which explains how you intend growing your business and identifies those areas and demographics you will be targeting. Before rolling out your first franchise, you will need to prepare financial forecasts and projections for at least the first three years. You may seek advice from a
franchise lawyer in order to do this effectively.
Further, you’ll require expert advice on whether your franchise business should be structured in an existing company, partnership or family trust. Different structures offer different levels of asset protection and can produce different tax consequences.
Intellectual property, such as trade marks, patents and designs will need to be registered to ensure that you have rights and legal protection if they are used or abused by competitors, franchisees or others who try to benefit from your ingenuity.
Among the other tasks you’ll need to address early on are developing your training program and operations manual, deciding on the fees you intend charging each franchisee, and making sure that these fees not only cover your expenses and provide you with a profit but are realistic and affordable from the franchisee's perspective. You may also require the help of a leasing consultant to negotiate leases with major shopping centres. Most importantly, franchisee selection criteria should be carefully considered because these are the people who will largely determine the success or otherwise of your business.
Legal documentation
The importance of getting the legal documentation right cannot be overstated. Inevitably, many franchisors and franchisees face disputes which, if not resolved, can damage the business. The main contractual document governing the relationship between a franchisor and its franchisees is known as a franchise agreement. The relationship is also governed by the Franchising Code of Conduct which requires franchisors to disclose certain information to prospective franchisees. This disclosure must be done by a way of a Disclosure Document, which is prescribed by the Code. All of your legal documentation must comply with the Code, as failure to do so is illegal and may result in the Australian Competition and Consumer Commission (ACCC) taking legal action against you. The legal documentation is too important to leave to a ‘jack of all trades’ solicitor. You need someone who is skilled in franchising law.
Other legal documentation which you may require includes:
1. Leases you are going to enter into or sub-leases or licences between you and your franchisees which will allow them to occupy premises.
2. Intellectual Property licences which allow the IP held by one of your legal entities to be used by some or all of your other entities and your individual franchisees.
3. Workplace Agreements and proper occupational health and safety procedures, as required by the Commonwealth’s Work Choices legislation and your particular State or Territory’s Occupational Health and Safety Act.
4. Other agreements which stem from the franchise agreement, such as acknowledgements by the franchisee about any representations you have made, confidentiality deeds, non-competition deeds and guarantees and indemnities.
Drafting your franchise agreement There are three main mandatory provisions, which need to be included in the franchise agreement:
1. Cooling-off. The Code requires that after signing the franchise agreement, a franchisee be given a 7 day cooling-off period.
2. Termination - with and without notice. The Code prescribes certain circumstances in which the franchisor may terminate the franchise agreement immediately and without any notice to the franchisee. However, the franchisor must follow a proper notification process in all other circumstances before terminating a franchisee.
3. Dispute resolution procedure. This sets out clearly the procedure that must be followed in the event of dispute.
Other important provisions include:
Grant of franchise. As a franchisor, you need to consider what rights are being granted under the franchise agreement, such as the right to use your intellectual property for a fixed period.
Term and renewal. How long will the grant last? Does the agreement permit the grant to be renewed and if so, is there a specified process to be followed?
Site and territory. You will need to consider the territory you are granting. Issues to take into account include the demographics of the proposed territory, the level of competition and whether the territory will be granted to the franchisee on an exclusive or non-exclusive basis.
Fees and payments. You must determine the size of the fees that each franchisee will be charged under the franchise agreement and whether these will be fixed so that all franchisees pay the same, or based on each franchisee's turnover. An initial up-front franchise fee may be appropriate to cover initial stock, training and other start-up costs. An ongoing royalty payment or service fee may also be applicable. Other fees may include a marketing levy and technology fee. Regardless of how you structure your fees, you must ensure that they are not crippling. Your franchisees need to make a profit!
Reserving your rights. The franchise agreement should clearly outline your rights in relation to any grant. You may wish to be free to compete directly with the franchisee within a particular territory or appoint additional franchisees within the same territory in the future. Your agreement should be flexible enough to allow you to develop your system in the future.
Franchisor's obligations. The franchise agreement should include at least the basic obligations which require you to:
a. provide initial and ongoing training on running the business
b. provide manuals which outline how each aspect of the franchised business should operate
c. market and advertise the system, and
d. protect the system and its integrity.
Franchisee's obligations. The franchisee's obligations are usually lengthy and include obligations of confidentiality, timely payment of fees, compliance with the system and the operations manual, appropriate use of your IP, accurate record keeping and reporting.
IP issues. As IP is crucial to running a franchise, you should ensure the franchise agreement clearly outlines the franchisee's rights and obligations in relation to using your IP. In particular, the agreement should include an acknowledgement that you own the IP, whether by right or licence. Provision should also be made requiring the franchisee to report to you any infringement of the IP. Your agreement should also restrict franchisees from registering similar IP and from using your IP once the agreement is terminated.
Minimum performance criteria. Imposing minimum performance criteria on your franchisees can help you identify those who under perform. Various factors, including gross sales and client base growth, can be used to set the criteria.
Stock. In almost all retail circumstances, the franchise agreement will make provision for minimum stock level requirements, payment terms and approved suppliers. Franchisors should be aware that the Trade Practices Act prohibits exclusive dealing, such as restricting franchisees from purchasing goods or services from competitors if there is likely to be a substantial lessening of competition. To avoid running foul of the ACCC, franchisors should ensure they receive specialised legal advice about this aspect of their franchise agreements.
Products and services. The franchise agreement may contain provisions about the price at which franchisees can sell their product(s). However, franchisors need to be aware that price fixing and resale price maintenance practices are prohibited under the Trade Practices Act and specialist advice should be sought. As a general rule, franchisors must never set a minimum price at which product is to be sold.
Reporting requirements and audits. The franchise agreement should require franchisees to provide you with sales reports, financial accounts and other statistics that you may require. This information will help you monitor your franchise system and identify underperforming franchisees. The agreement should also provide you with the right to inspect and audit each franchisee's books of account.
Insurance. The franchise agreement should require the franchisee to take out all appropriate insurances, and the policies should record you, the franchisor, as an insured party.
Guarantees, indemnities and warranties. To ensure that franchisees meet their obligations (particularly if the franchisee is a corporate entity), the franchise agreement should require the directors of the franchisee corporation to guarantee the performance of the franchisee and indemnify the franchisor against non-performance.
Assignments, transfers and sales. The franchise agreement should address the terms on which you will permit a franchisee to transfer or sell its franchised business. In particular, you may want the first option to purchase the business if a franchisee elects to sell. Alternatively, you may seek the right to vet and approve any prospective transferee.
Right of first refusal in relation to products. If applicable, you may want the right to buy back the products of the franchisee's business when the franchise agreement comes to an end. Provisions governing how such products should be valued if the parties cannot agree on a price should also be incorporated into the franchise agreement.
Conclusion There’s a lot more to a successful franchise business than just having a good product or a good idea and plenty of energy. In any business venture, there are bound to be disagreements and misunderstandings. By getting the legalities right in the franchise agreement, franchisors can build in safeguards which protect their rights and minimise the chance of disputes getting out of hand.
This article appears courtesy of
Mason Sier Turnbull.
13-Sep-2007