Buying a franchise
Thinking of investing your hard earned cash and the bank loan in a franchise? Purchasing a franchise can be a straightforward process but one that is best not rushed. Potential franchisees can take months in the search for the right franchise. Taking time to follow all the steps should help your decision to sign up to a franchise and make the commitment right for you.
Investing in a franchise opportunity is many things, among them a financial investment, a commitment to hard work, the opportunity to build your own business, an agreement to comply with the franchisor’s rules, a way to run your business with back-up and to hitch a ride with a well-known brand.
Buying a franchise is not a shortcut to making a fortune, nor is it a way to start a business without dedication and motivation; it is not about letting the franchisor build your business for you. If you decide franchising is for you, research is essential before you buy.
The following is a guide to the steps you will take in the buying process though the order may vary according to circumstances.
Initial research: Finding out all you can about franchising before you start can make the journey to franchise ownership a smoother ride. Contacting your local government body and making use of the publications available such as the guide to franchising produced by the Australian Consumer and Competition Commission will give you a head start.
Contact the Franchise Council of Australia and read its publication, The Franchisee’s Guide too. Visiting the franchising expos that take place in major cities across Australia throughout the year is an opportunity not only to hear about individual franchisee experiences but to seek free business and legal advice.
It may be that you have a particular franchise system in mind, or that you are positive about the type of franchise you want to buy, but just as likely that you will be attracted by the franchising concept, yet unsure of where your future lies.
Use all the resources at hand to ensure you thoroughly examine the options available: read Franchising magazine, visit www.franchise.net.au and sign up to the regular 5 Minute Franchising newsletter, go online and search for companies, brands or industry sectors you are interested in. Once you have conducted some rudimentary research it’s time to create a shortlist and to dig deeper into these options.
Sorting out your budget: Before you start to seriously consider the various options in franchising that appeal, getting an idea of what you can afford will help you focus your efforts and save time in the long run. This budget is a guide to what you can reasonably outlay in your first year of running the franchise so the purchase price becomes a foundation on which you can build a profitable business and not a financial weight on your shoulders.
Putting together a budget assessing the amount of risk you are prepared to undertake is important. Remember that if like most franchisees you require some funding from a financial institution, it will also evaluate the level of debt and risk you are considering.
Mortgaging the house has been a standard way of helping fund a franchise purchase but needs to be seriously discussed with partners and financial institutions. It is important to remember that any investment in a franchise is money at risk, and all of this money can be lost. The budget you compile also needs to include a figure for working capital – although some franchises provide a limited time income guarantee most do not and lack of cash flow in initial trading months has been the downfall of many a business.
Increasingly franchisors are looking at creative ways to encourage keen franchisees whom they consider to be the right fit for their brand but short of the total investment required, either by negotiating terms or by providing some funding themselves. Once you have a budget you can start to investigate the franchises that fall within your financial boundaries.
Initial applications: When you are ready to seriously consider a number of franchises your next stage is to make contact with the franchisors and get more information. It is quite common for franchisors to provide expression of interest forms on their website but you may choose to contact them by phone first.
Franchisors send out information packs that allow potential franchisees to investigate the offer further before following through with an informal interview. The packs usually contain a brochure which may outline a history of the company and its brand or brands, a guide to costs and the skills required by a franchisee. A confidentiality agreement and possibly an application form may also be included.
First interview: The first interview with a franchisor is an opportunity to question the franchisor extensively and in return you can expect the franchisor to interview you about your motivation for buying the franchise and your experience. Franchisors want to get the right fit for their franchise network just as potential franchisees need to be sure the franchise system suits their needs and personality.
Kim Davies, franchise development manager at Appliance Tagging Services, says: “Before I speak to prospective franchisees I provide them with some basic information and ask them to jot down any questions they have so that we can discuss during our meeting. This gives me a real opportunity to find out what is important to them.
“By listening to their questions I can get a feel for their expectations of the franchise. Often when people respond to questions they give the answers that they think you want to hear, but when they are prompted to ask their own questions they are more likely to be frank and open.
“For example, if a prospective franchisee’s first question is: “What hours will I have to work?” this tells me that they are really looking at buying themselves a job rather than committing to a business venture. This gives me a real indication of what they are looking for out of a franchise and helps me to decide not only whether I believe they would be suited to an ATS franchise, but also whether an ATS franchise would give them what they are looking for.”
The more questions that are asked and answered the less room there is for misunderstanding and for assumptions about franchisor and franchisee responsibilities to creep in. If both the franchisor and potential franchisee are happy to continue with the application process, the franchisee will be given a formal application form to complete. It might be this stage that location or territory is discussed.
Application form: The application form can in many cases require quite personal information in addition to the standard work and business experience questions. For instance details about your current income, any savings or assets, mortgages or debts, even whether or not you have undergone bankruptcy. The franchisor may want to know how you plan to run the business and if you have a partner, what their involvement will be.
Further interviews: It is likely the franchisor will want to have more detailed discussions with a potential franchisee. The more time spent finding out about the franchisee and franchisor relationship and whether the two parties can work together, the better for both.
A disaffected franchisee doesn’t make the money they want and won’t help the franchise network by building the brand. After one or more interviews have been completed, and both parties agree to continue, the franchisor will give the prospective franchisee the relevant legal documents prior to signing up for the system.
The disclosure document: Potential franchisees must be given a copy of the franchise agreement (in the form it is to be signed), disclosure document and a copy of the Franchising Code of Conduct at least 14 days before they sign any agreement or make a non-refundable payment.
Franchisors are required to advise their prospects to seek independent legal, accounting and business advice; the Code insists the franchisor receives a statement from the franchisee that they have sought such advice, or had been advised to seek it but decided against this.
A disclosure document may be in a short or long form depending on the franchise’s expected annual turnover. This document sets out in its long form information about the franchise such as non-renewals or terminated franchises, territory exclusivity, material conditions of financing arrangements, initial and ongoing costs, details about supply of goods. Also included should be references to the relevant conditions of the franchise agreement that deal with obligations of the franchisor (such as providing training), a list of existing and some past franchisees, and details of certain litigation.
Financial disclosure must include evidence in the form of a director’s statement confirming the franchisor is solvent, and either an independent audit which supports the director’s statement or financial reports for the franchisor for the last two financial years.
If the franchise is to be on a site leased by the franchisor, the franchisor is required to provide relevant leasing documents to the potential franchisee. For further information on the disclosure document visit www.accc.gov.au/franchisingcode.
It is unlikely the franchisor will provide projections of profit for the new outlet but it should provide enough financial detail for you to draw up a business plan, with figures based on past performances.
Due diligence: Undertaking further research so you are in a position to be confident in the business proposition is conducting due diligence. This should entail financial, legal and business analysis, as well as franchisee research. Imagine you were buying a house but didn’t conduct a building inspection or title search? Those actions are part of due diligence in a real estate transaction.
Getting independent advice: Potential franchisees should seek advice from accountants, lawyers and business advisors who know and understand franchising as part of their due diligence process explains Jason Gehrke of the Franchise Advisory Centre.
“This should be done as soon as the candidate has received their disclosure documentation, and should take as long as is reasonably necessary for all three advisors to provide specific written advice – even if it takes longer than the minimum 14 day period stipulated by the Code before a franchise agreement can be signed,” he cautions.
“Every additional hour and dollar spent on proper advice and guidance up front can potentially save a franchisee thousands of dollars down the line if they push ahead with a poor decision.”
Of course it requires an investment of time and cash to research information and pay advisors, adds Gehrke who recommends potential franchisees be prepared to pay at least between two and five per cent of the cost of a franchise on due diligence alone. So for a franchise purchase of $100,000, a potential franchisee should be prepared to spend between $2000 and $5000 on due diligence.
The largest expense in the due diligence process is the cost of professional advisors such as accountants and lawyers and as their work is normally charged at a projected or hourly rate, the greater the investment, the greater the diligence required, the more expensive these costs will be.
“While this could mean that the buyer will lose the cost of the due diligence by not completing the sale, this might be a very small loss compared to the cost of buying an unsuitable or unsustainable business,” Gehrke says.
The franchisee experience: Taking the time to question as many franchisees as you can about their business and the support received from the franchisor is time well spent. Many franchisors will also suggest potential buyers arrange to spend time visiting or even better, working within a franchise, because there is nothing like work experience to give a sense of what the day-to-day business will be like.
A business plan: Once you have spent time further researching the system you will need to outline estimated costs, cash flow and profit projections. There are a number of ways to evaluate the profit and whether or not it is likely to meet your goals, and be worth the investment and hard work that will go into building the business over the term of the agreement. This is where an experienced franchise accountant may be able to help.
Securing the funds: In assessing finance applications banks evaluate the ability of the borrower to repay their debt. The National Australia Bank has a dedicated franchise banking division; national manager Darryn McAuliffe says the NAB recommends applicants speak to their bank when they have decided franchising is for them and once they have performed due diligence on their chosen system.
“Apart from the applicant’s commercial background and the equity they can contribute, the bank will want to see that they have diligently and effectively researched the opportunity.
“Most importantly we would be looking to see that they have tested their cash flow and profitability projections and identified and considered any related risks such as seasonality and ability to cope with lower than anticipated revenue. The presence of risk is accepted and part of lending. The decision of whether to lend (and how much) is based on comfort that the risks have been identified and can either be mitigated or tolerated.”
The franchise agreement: The franchise agreement formalises, in a legally binding contract, the arrangements for the conduct of the franchise business and the roles and responsibilities of the franchisor and franchisee. Typically, agreements are comprised of a list of definitions or recitals that define important terms in the agreement, the main body and a schedule, explains John DiNatale, senior consultant at DC Strategy.
The agreement will generally cover the grant of the franchise, the use of intellectual property by the franchisee including operations manuals, payment of fees, performance of the franchisee and franchisor, promotions and marketing, the conditions relating to the sale or transfer of the franchise, provisions for termination, and the effect of the Franchising Code of Conduct.
The schedule will contain details of the specifics that relate to your franchise arrangement – location, territory, royalty and marketing levies, insurance requirements and any special conditions that have been negotiated. In addition, a franchise agreement will have attached to it a statement confirming that you have sought independent advice prior to signing and sometimes a non-compete and confidentiality statement.
“The franchise agreement can sometimes appear a little daunting, but it is vital that you understand it,” says DiNatale.
“Ultimately, this is the document relied upon should there be any litigation between the parties. As such, seeking specialist advice is highly recommended. Your garden variety lawyer usually has little or no experience in franchising. Find a specialist in this area and preferably one who has an understanding of the commercial as well as legal aspects. What you should be looking to understand is what the various clauses of the agreement mean in a range of “what if” scenarios.
“A specialist may suggest that you seek amendments to the agreement, or in some cases, recommend that you don’t sign it in its current form. Good advice at this stage will save you money and heartache down the track.”
Cooling off period: Franchisees have a seven-day cooling off period from the time of signing the agreement or making a payment under the agreement (whichever is done first). If the franchisee opts out of the system within this period, a refund of the money invested must be paid by the franchisor within 14 days though the franchisor may be allowed to deduct reasonable expenses from this figure.
Training: Franchise Careers director and former franchisor general manager, Corina Vucic, says: “Operational training is essential for all new franchisees. The hands on approach including how to ring up a sale, count stock, manage day-to-day inventory and provide exceptional customer service is a necessity for any business, not a luxury.
“Induction programs teach the franchise system, how to use the operations manual, follow the system and who to call when requiring support.
“Franchise induction programs vary in length depending upon the complexity of the franchise footprint. On the job and classroom training in a retail franchise varies from seven days to 12 weeks. The training is conducted prior to the franchisee opening their Greenfield site or acquiring an existing business.”
Opening the business: Don’t forget about marketing, staff recruitment, store build and fit-out, stock and equipment. Some or all of these will need to be put in place before the franchise opens its doors for business.