Franchise Systems Group and what you need to know before you sign a franchise agreement

According to Franchise Systems Group , a franchisor does not need a license to become a franchisor, so how do you know whether your investment in a franchise is safe? The Franchise Code of Conduct goes some way towards ensuring that potential franchisees have sufficient information before deciding on investing in a franchise opportunity. That said, the information provided in the disclosure document is only the starting point to gaining all the information you need. After you peruse your preferred franchisor’s disclosure document, what’s next? The answer is simple, and can be summed up in three words: good professional advice.

The advice of your lawyer, accountant or franchise specialist will be priceless! That’s because it is their job to raise with you the questions you need to ask of your preferred franchisor. Do not make a decision regarding a franchise purchase before speaking to an experienced professional.

After gathering information from the franchisor directly and your lawyer, accountant or franchise specialist, it is imperative to speak to existing franchisees currently within the franchise system you are interested in joining. If you are considering becoming the very first franchisee in a new franchise system – what is termed as a foundation franchisee – you will need to rely more on the franchisor for your information. If you are considering joining an established franchise system, you can obtain information from the franchisor and other franchisees within the system.

Groundwork for ‘foundational’ franchisees

If the opportunity is to become a foundation franchisee, ask more questions about the existing business being run by the franchisor. Understand that investing in a new franchise carries its own risks and/or rewards. A new franchise system offers a ground floor opportunity to get involved. However, it is more risky because you have no evidence from current franchisees as to its viability.

As a prospective foundation franchisee, you will need to check how the concept has worked so far for the franchisor. How did they earn their income and can you do it the same way? What marketing will they undertake to establish the business? What business background do they have? Do they know the market well? Have they used franchising specialists to help establish the system? Make a list of questions (don’t be afraid to ask too many!), get answers, and be suspicious if you can’t.

Groundwork required for established franchises

Established franchises offer a reduced risk as their concept is proven. However, some systems that have grown to a large size are finding that new sites may not be as good as some of their previous ones, and may not work as well. Getting the right assistance in making your decision is vital, so talk to your lawyer, accountant and/or franchise specialist.

Remember also to extensively question a wide selection of franchisees already within the franchise system, in addition to the franchisor. Again, a franchisor or franchisee’s reluctance to answer your questions should be viewed with suspicion.

Finance

Government grants and funding programs: Grants and other funding programs are available from the Federal, State and Territory Governments, and in some cases, from local councils. Generally, there are no grants available for starting a business. However, there are grants and other assistance available to people in regional areas.

For example, the New South Wales Department of State and Regional Development (DSRD) has a range of small business programs available. One example is their Stepping Up mentoring program, which is a three to four month program of workshops and mentoring. Other examples offer financial assistance specifically in the Illawarra and Hunter regions.

To find out what financial assistance is available, check out the Development and Innovation departmental websites in your respective state or territory.

Raising the Finance: There are numerous options a prospective franchisee can consider when it comes to finance. Your financial adviser or mortgage broker should be able to arrange a loan – provided you have sufficient equity in your home. You will have to be absolutely sure that you are willing to risk your home, if the business failed.

The major banks are now focusing on the franchise sector. The great advantage is that, if the bank has accredited the franchise system, then the bank is prepared to lend a proportion of the value of the business using the business as security.

Remember, if you need more than the banks are willing to lend, you must source the remainder of the funds from your own cash, or borrow against your personal assets.

The accredited systems are usually those with a minimum of 15 to 20 outlets, which have a minimum value of $100,000 to $150,000. Great for many retail franchises, but not so for service franchises, which are generally worth under $100,000.

Don’t forget when looking at your borrowing needs to ascertain whether you will need any working capital in the early days of the franchise. A retail outlet in a major shopping centre will generally be cash flow positive from the moment you start, yet a business-to-business franchise will take a long while to generate sufficient turnover to pay all your normal bills.

Franchise Fees

One of the most commonly asked questions from prospective franchisees is: what fees do I have to pay? Each franchise system is different, so be sure to find out from the disclosure document what payments – both initial and ongoing – are expected.

Upfront Fees: Firstly, there will be fees paid to the franchisor before you even start. The ‘initial franchise fee’ is the cost to enter the system and gain the right to use the name, intellectual property and operating system developed by the franchisor. You may also be asked to pay a ‘training fee’, which will cover the cost of your initial training so that, on the day you start in the business, you will know exactly what to do. There could also be an ‘initial promotion fee’, which is used to promote your new business in its location or territory. The franchisor will have developed the methods that work in their system and will focus on getting your business running as quickly as possible.

Royalties: ‘Royalty’ is the word often used for the ongoing payment made by a franchisee to a franchisor for the use of the brand name and system, and for continued support. A better definition of this is ‘franchise service fee’, as it is an ongoing fee for business, management, technical and marketing support. Be sure to check with existing franchisees as to what sort of support the franchisor provides. Some fees are based on turnover and some fees are a fixed payment.

The percentage of turnover that a franchisor requires varies greatly according to the support that is given. Expect to pay a higher percentage if the franchisor offers extended services, such as order taking, work scheduling, debt collection, administration, etc. Fixed fees are calculated either on a straight cash per week/month basis, or on the cost of a set number of services per week/month. Some franchises do not have a franchise service fee or royalty. Instead they earn their income from the sale of stock to the franchisees to sell in their outlet. Usually, these products are exclusive to the franchise system and cannot be obtained elsewhere.

Marketing and Advertising Levies: Marketing or advertising levies are collected by most franchisors. The money is pooled and used by the franchisor to promote the whole system for the benefit of all franchisees, allowing the system to compete effectively against the competition. Check that the franchisor also pays into the fund, if they run company outlets. This fee can be a fixed fee or dependent on turnover.

Fit out

The fit out fee is sometimes included in the one total investment figure suggested by the franchisor. The franchisor provides a ‘turnkey’ solution to the franchisee, so that as soon as they complete their training they can commence at the premises, with everything installed and working correctly. In the majority of the cases, the franchisor uses their knowledge and skills to work with the franchisee to fit out the premises in the most cost-effective fashion, whilst ensuring the standards of design and layout conform to the franchisor’s specifications.

The franchisor will give an estimate of this cost in the disclosure document, but every site will be different and will have its peculiarities. Invoices will be sent directly to the franchisee, so that they can keep a close eye on costs.

If the site is in a major shopping centre, check with the franchisor whether there is a contribution available from the landlord to assist with building works or fit out. All of these fit out costs are in addition to the initial franchise fee.

Training

The initial training of a franchisee is crucial for their long-term success. The development of a comprehensive operations manual is a precursor to this, as the franchisee will need to be aware of how the business operates.

For many new franchisees, it is the first time they have been in business for themselves, so it is important to check with the franchisor what is included in the initial training. From our experience, more and more franchisors are including accounting software packages in the initial set up costs, in addition to a full day’s training at the franchisee’s place of business to set up the accounts and ensure that the reporting structure is common throughout the system. This will also give franchisees an understanding of the importance of cash flow in the business.

The more enlightened franchisors are also including the services of a business coach in the first few months of a franchisee’s life in the system, to ensure that they are taught better ways of running their business and organising their own time and priorities.

Marketing and advertising considerations

As part of your due diligence in investigating a franchise opportunity, it is important to understand how the franchisor markets the business and whether it is a process that you can handle. The advantage of buying a franchise is that the franchisor has usually spent many years making lots of mistakes in trying to develop the ideal marketing plan. The franchisor should have a very good idea of what works in their particular business and what doesn’t. Be sure to ask them.

Checking with existing franchisees is important. They will be able to tell you whether the marketing is working for them or not. If your franchisor is asking for an initial promotion fee, check how this is to be spent over what period of time. It is no good blowing all of the money, at the beginning, in one huge campaign that does not work.

Discounts

The market place is a great leveller. Franchises always seem to be able to sniff out a cheaper price for a product, but care must be taken to ensure that it is exactly the same product. If the product is exclusive and cannot be purchased elsewhere, it is an advantage for the franchisee, as the margins will generally be higher than a nationally branded product.

Ask the franchisor to discuss the ranges of products to be sold and their sources of supply. Do you have the opportunity to shop around?

In some cases, franchisors rely on the rebates earned from third party suppliers for their income. If this is the case, you can expect the franchisor to be insistent that you use these suppliers. However, in many cases, these rebates are to a franchisee’s advantage, as it means that the franchisor may not have to charge an ongoing franchise service fee.

Support from the franchisor

One of the reasons people invest in a franchise is because they know that a good franchisor will train people properly in the operation of the business, and offer support on an ongoing basis. That is the reason for ongoing fees to be paid. For a franchise system to be successful the franchisor must exert a tight control over the system and the franchisee must follow the methods laid down by the system.

The principal reason for this control is to safeguard the public's ability to rely on the franchisor's trademark as an indicator of the system's products or services – knowing that these products or services will be delivered consistently, wherever they happen to be. The operations manual is the detailed ‘bible’ for the day-to-day operation of the franchised business. The franchise agreement will provide that the franchisee must observe the operations manual and that the franchisor may update it from time to time. Franchisees should insist upon seeing the manual prior to signing the franchise agreement. Another reason for the franchisor maintaining control is to protect the franchisees themselves, who are reliant on the franchisor, ensuring that other franchisees do not do harm to, or diminish the value of the business. The franchisor may also include services such as centralised accounting, call centres or work scheduling. The cost of these services will normally be reflected in higher franchise service fees.

Technology, equipment and fixtures

The disclosure document will outline, in detail, all the equipment that a franchisee will need to purchase prior to opening the business. In some cases, you will have some of the items, such as a PC or mobile phone. However, for more specific items that relate to the franchised business only, you should clearly identify what you will have to provide.

For sophisticated equipment such as point of sale (POS) terminals and back office software, the franchiser will have already decided on the system that they will use and will specify the equipment required.

For basic office equipment, the franchisor will often specify the type of equipment, but not necessarily the supplier. The franchisor is also able to negotiate better deals with the banks for the use of EFTPOS facilities, so that the franchisee will be able to save on the commission for accepting credit cards.

Leasing the equipment is an opportunity if the franchisee does not want to use all of their capital.

Finance brokers and financial institutions will be able to help and, in some cases, the franchisor will have negotiated good deals with finance companies. There are many things to consider when buying a franchise beyond those discussed already in this article. The secret is to get good help and advice. It is well worth the cost, especially when you consider the risks involved in buying into the wrong system. It is also a requirement of the Franchise Code of Conduct.

Read about buying a franchise and running a franchise.