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How to avoid a scam franchise

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Inside Franchise Business: avoid franchise scamsThere is an abundance of franchise opportunities in Australia but along with a rise of franchise systems  comes a rise in franchise scams.

Scam franchises may appear to be professional and reputable businesses on the surface.  This is why it is important for prospective franchisees to take adequate steps to protect themselves to avoid being a victim of a scam. 

What scam franchises don't include

There are some tell-tale signs that a franchise opportunity may not be all that it seems. Here are some items that you should ensure are included when considering any franchise opportunity:

Realistic financial gain

If it sounds too good to be true, then it most likely is. Running a franchise is hard work and franchisors are unable to guarantee a certain profit or salary. 

Franchisors need to manage expectations and will ordinarily not provide forecasts or forward looking information to prospective franchisees  -nobody has a crystal ball so such information is often Unreliable.

Historical financial information can sometimes be useful, but isn’t necessarily a good guide to future performance.  You should be particularly cautious when a franchise business has no trading history.

Full disclosure of information

In Australia, franchisors must comply with disclosure requirements as set out in the Franchising Code of Conduct.  As a prospective franchisee, you must be supplied with a detailed disclosure document, which contains important information regarding the franchise, a copy of the franchise agreement to be entered into and the Code of Conduct. 

A franchisor also needs to provide you with an information statement and certificates of independent advice (that is, a certificate which states you have either received independent professional advice or have chosen not to). 

This is the most important step to avoid scam franchisors, and franchisees should never sign a franchise agreement without full disclosure.

Disclosure period

In addition to the supply of a disclosure document and other relevant material, a prospective franchisee is given a 14 day disclosure period to review disclosed materials before formally signing up to the franchise. 

This time is to allow you to consider the benefits and any risks involved in entering into the franchise business, as well as receive advice from your lawyer, accountant and/or business advisor – so make sure you use it wisely. You should be wary if a franchisor is trying to push you into signing anything before the disclosure periods lapses.

Cooling-off period

The Franchising Code of Conduct provides new franchisees witha cooling-off period. 

As a franchisee, you may exercise your cooling-off rights within seven days of executing the franchise agreement or paying the franchisor a fee. You will be entitled to a refund of the payments you have made (however, note that this does not include any professional advice you choose to get prior to signing and the franchisor may retain some funds for admin costs). 

If the franchisor does not offer you a cooling-off period, it is not complying with its Franchising Code obligations.

Initial franchise fees

Franchisees will almost always pay an initial franchise fee when signing up to a franchise.  This will cover a portion of the franchisor’s costs to get the franchise up and running.  However, you should consider whether you are paying too much. 

If the franchise is an established brand, this may justify a considerable franchise fee.  However, if the franchise system is new or you are only getting limited training and support, query the benefit to you of sizeable upfront franchise fees. 

Due diligence

As a prospective franchisee, you should also do your own homework on the franchise. Do not only rely on information fed to you by the franchisor – do some research online, read forums, ask around and most importantly, seek professional advice.

If the franchise business is new, find out whether there is much competition in the market place. If the franchise is existing, try and collate as much ‘intel’ to ensure you can make an informed decision before jumping in.

Talk to other franchisees

We also recommend speaking to others franchisees within the franchise network, if possible.  If a franchisor is operating a sound franchise network, it should not hesitate to provide you with a full list of other franchisees. 

If a franchisor is only prepared to provide you with a couple of other franchisee names, this will most likely be because the network is not very successful and there is no reasonable explanation – franchisees should proceed with caution.

Get professional advice

Having a lawyer, an accountant and a business advisor look over a franchise proposal will help you avoid signing up to a scam franchise.  Such professionals are experts at identifying potential risks and red flags when it comes to franchises. 

Obtaining such professional advice before you take up a franchise opportunity is a wise investment to limit the prospect of being scammed or defrauded.

By Warren Scott, partner and Cassandra Taylor, lawyer, at Mills Oakley

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