One reason for this growth is that more people are realising that becoming a franchisee can often be much cheaper and much less of a risk than setting up their own business. They also realise that as franchisees they will not have to reinvent the wheel. They can buy their way into an operation which has ‘tried and tested’ products, systems and procedures, guaranteed suppliers and a brand name that is not fighting to make its presence felt.
However, before investing in a franchise business, prospective franchisees need to do their homework. In addition to having the necessary capital, they must have trust and confidence in the franchisor – the person who owns the franchise system. They also need to know they can trust the franchisor’s systems and ways of doing business. The best ways of doing this are to make an assessment of the franchisor’s character, conduct their own research and ask questions of franchisees that have joined the franchising chain.
While the franchisor might willingly provide much of the information, potential franchisees need to consider the following and also make their own enquiries:
Find out as much as possible about the organisation you are thinking of joining and about the franchisor’s reputation;
Try to find out how much demand there is for the goods or services offered by the franchised business in the area where your store will be located;
Make an assessment of the strength of the franchisor’s brand;
Evaluate the proposed site’s ease of access for customers and for suppliers to make deliveries;
Try to gauge how much direct and indirect competition there is in the area;
Decide whether the demographic information provided by the franchisor is adequate or whether an independent assessment is required;
Undertake company searches, litigation searches, trademark searches, permit searches, and make any enquiries you consider relevant and necessary. If the franchisor is being sued or is threatened with legal proceedings, its brand name, its reputation and your investment could be at risk. The same may be true if the franchisor does not own the intellectual property that makes its business successful.
Ask the franchisor to explain its expansion plans. Does the company intend setting up another store in the area that will compete with yours for business?
Make doubly sure that the bank will lend not only the initial sum required to get started but also money for all the capital requirements.
Business plans and budgets
Every prospective franchisee needs to prepare a business plan and appropriate budgets, preferably with the help of a qualified accountant experienced in franchising. The franchisor is under no obligation to forecast what financial success a prospective franchisee can expect and will typically avoid detailed discussions on this topic. Some large franchisors provide estimates of what the franchisee’s future earnings might be but these are based on generalisations and numerous variables. They will rarely be indicative of how things will pan out for each franchisee.
Essential documentation
Under the Franchising Code of Conduct (Code), each franchisor must give all potential franchisees a copy of what is known as a disclosure document. This must include a draft franchise agreement and a copy of the Code and be made available at least 14 days before franchisees sign their franchise agreements. Typically, the franchisor will require that potential franchisees advise the franchisor in writing that they have read the franchise documents and received independent legal, accounting and business advice. If a decision has been made not to obtain that advice, the potential franchisee should be asked to sign something to that effect.
Potential franchisees should also consult an accountant about what fees are payable under the franchise agreement and whether or not they can be met from the gross turnover of the franchised business. Once again, it is highly advisable that the accountant retained to assist in buying a franchise has franchising experience. Further, potential franchisees will also need the services and advice of a lawyer specialising in franchising. The lawyer will need to review the franchise agreement and disclosure document and make sure they contain no hidden provisions that might disadvantage or mislead.
Cooling off
Once the franchise agreement is signed, a seven-day cooling-off period applies. However, a similar cooling off period does not apply when the franchise agreement is renewed, extended or transferred. If the franchisee decides not to proceed, the Code requires the franchisor to refund money paid under the franchise agreement, less a reasonable amount retained for its costs.
Mandatory terms
Under the Code, the franchisor is required to insert certain terms into the franchise agreement. These include provisions that:
1) the franchisor cannot prohibit franchisees from meeting together for a lawful purpose
2) the franchisees are not to sign a general release in favour of the franchisor
3) if there is a marketing fund, details of its expenses. It should be noted that all marketing funds need to be audited.
4) the franchisee’s accounting records must be made available to the franchisor
5) the franchisor must consider any request for its consent to assign or sell the franchise within a certain timeframe and can refuse consent only under certain (limited) circumstances
6) the franchisor must give notice when requiring breaches of the franchise agreement to be remedied (except for a couple of grounds which allow immediate termination under the Code) and provide the franchisee the opportunity to remedy those breaches within a reasonable time before it can terminate the franchise agreement, and
7) the franchisor can terminate the franchise agreement without notice in a limited number of circumstances, which are specified in the Code.
Other issues
When reading the franchise agreement, it may also be appropriate to consider some of the following issues:
1) will the territory granted be an exclusive territory?
2) who will be responsible for selecting the site or defining the territory?
3) how much initial and future training will be provided and what will it cost and who will pay?
4) what goods and/or services will the franchisee have to sell or provide?
5) who will be supplying the goods or services?
6) what fees, if any, will be payable?
7) what will the trading hours be?
8) does the industry in which the franchise business operates fall under a common rule or federal award? If so, does it set out minimum employment terms and conditions?
9) which specific procedures and manuals will the franchisee be required to follow?
10) what will be the minimum performance criteria?
11) will there be a lease or licence to operate the business from the business premises and who will hold the head lease? What will the terms of that lease or licence be – and who will pay the landlord’s costs?
12) will a permit be required to operate the franchised business?
Costs
A potential franchisee will need to estimate all the expenses payable to set up and operate the franchised business. These will include but are not limited to: the initial franchise fee, ongoing franchising fees, marketing fees, working capital, the cost of fit-out, stock, inventory, tools and insurance, as well as fees to accountants and solicitors.
The disclosure document and the franchise agreement should be read carefully. In addition, the potential franchisee should speak to as many other franchisees as possible about their experiences with the franchisor.
Intellectual property
Intellectual property (IP) includes registered and unregistered trademarks, patents, copyright, designs, trade secrets, confidential information, know-how, advertising materials and manuals on practices and procedures which the franchisor will allow its franchisees to use under licence.
Details about this IP must be disclosed in the disclosure document. The solicitor engaged to review the franchising documents can conduct basic searches of the IP being licensed as part of the document review process. Given that this is an important aspect of franchising, the intellectual property should be properly developed and adequately protected.
Disputes
The Code includes specific requirements for using mediation for resolving disputes between franchisors and franchisees. Mediation is a procedure in which an independent person is appointed to facilitate a meeting between the parties to discuss and hopefully resolve a dispute.
A Code-compliant dispute resolution procedure set out in the Code must be reflected in the franchise agreement – and potential franchisees and their advisors should review that provision carefully. The dispute resolution procedure must be properly understood, including where the mediation can take place, as it could be in another state or country.
Conclusion
It is imperative that people considering the purchase of a franchise conduct their own research and obtain proper professional advice before committing to a particular franchise system. Remember – it is much easier to get into a franchise than it is to get out.
Find out more about buying a franchise or running a franchise.