Franchising Flaws: Buyer Beware

• Franchise Agreement
• Lease Agreement
• Disclosure Document – franchisors must provide this document to prospective franchisees to comply with the Franchising Code of Conduct as set out by the Trade Practices Act.
• Sale of Business Agreement - in cases where an existing franchise business is being purchased. This will include a Disclosure Document from the franchisor and existing franchisee.

2. Collect as much information about the franchisor and franchise business as possible (from the press, internet, industry sources). This will help you assess whether it is the type of business you want to be involved in, and its profitability.

3. Arrange to spend some time observing, or, if this is possible for you, actually working in the franchise business.

4. Speak to other franchisees about the franchise system. Ask them about the level and quality of support provided by the franchisor.

5. Check the business location, plus the location of other franchises or similar businesses which may compete with and affect your business profitability.

6. Check the total cost of buying the franchise, including:

• Establishment costs.
• Purchase of equipment, stock and supplies. Is a vehicle needed for the business?
• Rental of premises and/or vehicle including outgoings.
• What franchise fees are payable? Are there ongoing fees involved, such as group advertising, training costs, or any other fees?

7. Check the profitability of the franchise business. It is not sufficient just to look at sales turnover figures of the business in isolation. You also need to know what the operating expenses are. You should make an allowance for your salary if you are going to be working in the business and the cost of any financing.

8. Compare the profitability of the franchise business that you are looking at buying with key performance indicators relating to existing franchisees and other franchise systems. The franchisor should be able to provide you with figures as to how profitable the business is when compared with other franchisees within the system.

9. Check the Disclosure Document provided by the franchisor for anything that may affect the profitability of the business including increases in operating expenses, fees payable to the franchisor and cost of products supplied by the franchisor or third party. If the Disclosure Document is silent or does not make adequate disclosure, make further enquires.

10. Some franchisors require prospective franchisees to pay a deposit before providing them with Disclosure Documents, franchise agreement and other documents or signing the franchise agreement. If this is the case, make sure that the deposit is treated as “trust money” and paid into the trust account of either your or the legal franchisor’s and not released to the franchisor until you have decided to proceed with the purchase. If you do not take this precaution, you lose your deposit if the franchisor goes into liquidation or administration before the transaction is finalised or you decide not to proceed.



From a legal perspective, the Disclosure Document and Franchise Agreement require careful legal scrutiny to ensure that the franchisee’s investment is protected. Having worked in the franchise industry for over twenty years, I have had exposure to numerous franchise systems and franchise agreements. Each system and agreement is different and has to be considered on a case by case basis. The legal issues are complex and review is recommended by lawyers who are experts in the area.

Provisions in Franchise Agreements which would raise concern include:

• Ongoing franchise and marketing fees being out of proportion to the sales turnover and profitability of the business;
• The franchisor being able to increase franchise fees unilaterally by giving written notice to the franchisee, without any cap on the increase;
• The franchisor being able to make major changes to the franchise system, without consulting the franchisee;
• The franchise agreement not giving the franchisee any express right to terminate the franchise agreement in case of breach of the franchise agreement by the franchisor or franchisor becoming insolvent;
• The franchise agreement placing restraints on the franchisee continuing to operate the business under another name or operating in competition, where the franchise agreement has been terminated because of non-performance or breach by the franchisor;
• The franchise agreement placing unreasonable conditions on the sale or transfer of the business including claims to goodwill in the franchisee’s business or payment of large transfer fees to the franchisor;
• Requirements that the franchisee pay the franchisor liquidated damages that are in fact penalties, where there is a breach of the franchise agreement by the franchisee;
• Franchise Agreement not containing adequate protection for the franchisee, where the franchisor sells or otherwise transfers the franchise system or intellectual property to a third party.

In conclusion, as a basic rule, the franchise agreement must comply with the Franchising Code of Conduct and be fair and balanced in protecting the investment of both the franchisor and the franchisee. A successful franchise system involves both the franchisor and franchisee operating profitable businesses. The franchisor’s success is ultimately dependent upon its franchisees doing well.


Disclaimer : This article is not intended to be a substitute for obtaining legal advice.

[1] Franchising Australia 2006 Survey prepared by Lorelle Frazer, Scott Weaven and Owen Wright, Service Industry Research Centre, (Griffith University 2006) page 13.
[2] When the Franchisor Fails Research report prepared for CPA Australia by the University of New South Wales, (CPA Australia, 2006)
[3] This figure was obtained through searching the Commonwealth of Australia Gazette. The search was limited to companies that contained the term “Franchise” or “Franchising”. Difficulties arise ascertaining the exact number of franchise system failures as there is no public record.
[4] 1.9 million businesses in Australia: ABS, Australian Bureau of Statistics, Media Release Summary 26 February 2007
[5] Counts of Australian Businesses, including entries and exists June 2003 to June 2006, Australian Bureau of Statistics, 26 February 2007