Think you’ve found the perfect business opportunity? Before you sign anything, you must be across all aspects make sure. Here, Mick Keogh, deputy chair, Australian Competition and Consumer Commission (ACCC) share his five must-learn lessons in assessing a franchise.
If you are looking to buy a franchise, a recent review of food franchises has uncovered some concerning practices that could impact you (the buyer). The ACCC’s findings are relevant to all types of franchise businesses.
As with any business, there can be risks and rewards in franchising. Read on to learn how to detect poor practices and protect your investment.
Assessing a franchise
The Franchising Code of Conduct (the code) sets out requirements for the franchising industry to follow. Under the code, the franchisor has to give certain documents to a buyer when they are considering purchasing a franchise. This includes the franchise agreement, disclosure document, information statement and a copy of the code. These documents can
help with your research to decide if franchising in general, or the particular franchise, is right for you.
The ACCC enforces the code in line with its Compliance and Enforcement Policy. As part of our role, we undertook compliance checks on 12 different franchisors in the food services sector. We found five key things:
- most franchisors made it too difficult to contact former franchisees
- most franchisors did not adequately disclose what essential goods were subject to supply restrictions
- most franchisors had supply restrictions, did not share rebate benefits directly with franchisees, and could set maximum retail prices that the franchisees could charge
- some franchisors did not sufficiently disclose key unavoidable ongoing costs such as wages or rent
- 40 per cent of prospective franchisees do not get independent, professional advice before buying a franchise.
Based on our review, we have developed five key tips for someone looking to buy a franchise of any kind.
1. Talk to former franchisees
You won’t get a realistic idea about franchising without talking to former franchisees about their experiences. Franchisors must give you a disclosure document containing the contact details of former franchisees from the past three financial years unless they receive written notice from the franchisee requesting otherwise. You then have 14 days (sometimes more) to make contact.
If a franchisor deters you in any way from making contact, this is a big warning sign to walk away. If a former franchisee is contactable but doesn’t want to talk, this may also be a warning sign.
In our review of franchisor documents, we found only one in three of the franchisors consistently provided contact details for former franchisees, like mobile numbers and personal email addresses.
If you aren’t given contact details that make it easy to make contact, you may want to reconsider the franchise. Contacting current and former franchisees is vital as it allows you to test what the franchisor has told you, and to get another view on the site’s past performance. For example, if it has been a franchisor- operated site, past performance may not reflect what a franchisee could achieve.
2. Understand whether you can shop around for essential goods and services
In franchising, a franchisor can specify where you must buy goods and services that you will use to operate the franchise business. This is called a “supply restriction” and is usually legal. Supply restrictions are common in franchising as they can help ensure minimum product quality standards across the franchising network.
It is important to know if you can only buy certain goods or services that are essential to running the franchise from limited suppliers – for example, if you’re running a bakery franchise and you can only buy flour from one supplier.
Our review found that most franchisors had supply restrictions. However, seven of the 12 franchisors didn’t provide adequate detail about what goods and services were restricted.
If the disclosure document you get from a franchisor does not clearly state the type of goods or services that have supply restrictions, you should ask them for more information. If they are unwilling to provide the information, you should reconsider the franchise. You should also speak to current franchisees to verify what you’ve been told about supply restrictions and how they work in practice.
3. Understand whether the franchisor can set a maximum price for the things you sell
Our review found most franchise agreements contained a clause allowing franchisors to set the highest price that you can charge for the goods or services you sell. This is often used in promotions that apply to the whole franchising network, for example, a promotion selling cups of coffee for $3 with the aim of securing new customers.
This arrangement may result in an overall loss on the promotion for some franchises in the network. This can be due to input costs that stay the same, such as coffee beans.
In our review, we found maximum retail price clauses were common, as were supply restrictions, and rebates that go to the franchisor, not the franchisee. Supply restrictions, and rebates that are not shared directly with you, can make inputs (like coffee beans) cost more or result in inflexible costs, as franchisees can’t shop around for cheaper beans.
Maximum retail prices, supply restrictions and franchisor rebate arrangements show just how important it is to understand (before you sign up) that there can be a lot of restrictions imposed on you when running a franchise business. If you sign the franchise agreement, you will have to comply with these contract terms as long as it is not unfair. 1
4. Know the cost of running your potential franchise
To understand if franchising is a viable business option you must know the costs of running the business.
Under the code, franchisors must disclose certain costs. However, our review found that one in three franchisors did not sufficiently disclose key unavoidable costs such as wages, rent and inventory. These are basic costs essential to running most franchises. If these aren’t listed in your disclosure document or are understated, it could be a big warning sign that you aren’t getting proper information on costs.
5. Get advice, and make sure it is more than just legal advice
Our review found at least 40 per cent of prospective franchisees did not seek any independent professional advice before entering into a franchising agreement. This is very concerning, given many franchises can cost hundreds of thousands of dollars just to set up.
To help get a realistic view of how the franchise works and whether you can get a return on investment or draw a wage, you should obtain independent advice from professionals who are experienced in giving franchising advice. It is important to seek legal, accounting and business advice. Getting one type of advice is usually not enough. A lawyer will not be able to advise you on business longevity, business growth or return on investment.