How to spot franchising red flags

Many franchisees and prospective franchisors don’t realise that there are very few barriers to becoming a franchisor.

There are no Government applications to complete, no documents to be filed, and no authorities that check on a franchisor before the franchisor can go to market. The Franchising Code of Conduct as part of the Trade Practices Act describes what a franchise is and the nature of the disclosure that must be provided to prospective franchisees.

This law is policed by the Australian Competition and Consumer Commission (ACCC) and legislation backs this with a series of remedies and penalties that will apply if a franchisor is found to be in breach of this black letter law.

Unlike the United States, where about two thirds of the states require franchisors to register before commencing franchising, Australia has no such restriction.

Inability to determine the numbers

How the economics of the business work at the single unit franchise level and the magnitude of income and profit one might expect to make from the conduct of the franchise business will be crucial for future planning. An intending franchisee should not be seeking forecasts from the franchisor, and the franchisor should never provide forecasts to a franchisee.

The franchisor is not compelled to provide any financial information on the future or past performance of individual units and can choose to provide no financial information other than initial capital costs that require disclosure under the Franchising Code of Conduct.

Initial and ongoing training programs and support

The very nature of franchising implies that a franchisee buys into a franchise network to get access to know-how and expertise and systems and processes of the franchisor’s proven business system. A franchisee that is at the franchisor’s doorstep because he or she does not possess the experience or knowledge of how to conduct the business will require a franchisor to have a well-structured induction and training program – both prior to and during the start-up phase of the franchise business unit.

Advertising and marketing

An organisation’s brand and the strategies it is currently conducting, and proposes to conduct in the future, will be an important discriminator in a competitive environment. Danger signs are franchisors that believe it’s only location that makes sales and have no defined marketing strategy, or who commit a miniscule component of their revenue to advertising. This often means that a franchisor may have little ability to promote their products and services as the network grows and competition increases.

Group purchasing power

Another benefit of a good franchising system is the ability to purchase the stock and consumables of the business at competitive prices and create an opportunity to increase gross profit margins for franchisees as the network grows. These purchasing benefits often help pay for part of the royalties. In some of the bigger networks, the purchasing power of the network virtually pays for the total royalty when compared to any independent counterpart.

Franchisor/franchisee relations

The relationship between a franchisor and their franchises is one of the most important indicators in looking for red flags. Not all franchise owners will be in a blissful relationship with their franchisor, but as due diligence is conducted and one finds more and more franchise owners that are dissatisfied with their relationship with the franchisor, the stronger the warning signs.

Cultures and values

While some may consider this is a bit too ‘touchy-feely’, the culture and values of an organisation are often the big differentiator between competitors who are offering similar products. An appreciation of what motivates a franchise organisation will assist in diagnosing the deadly viruses of complacency, lack of enthusiasm and turmoil throughout a franchise organisation. Asking for an opportunity to meet some of the operations people and having a conversation about their degree of satisfaction, what they think of the organisation and the staff turnover will go a long way to determining whether the business might have an affliction that will compromise one’s future financial health.

Read further information about Franchise Council of Australia is a not for profit membership organisation that is the peak body representing the franchising sector in Australia.