Study reveals franchisees skimp on business research: what you need to do next

By Sarah Stowe | 31 Mar 2016 View comments

You’re looking to buy a business and have to conduct due diligence but you don’t know what it is. Well, you’re not alone.

In fact fewer than 20 percent of franchisees and independent small business owners really understood the term ‘due diligence’ before they invested in their business.

This statistic has emerged from an online survey of 610 existing and former franchisees and independent small business owners.

For anyone about to buy a franchise it’s important to fully research the opportunity and identify the commercial and legal risks – that’s what the due diligence process is all about, and it can be easily done by any potential franchisee.

But this study reveals franchisees are skimping on their research, and later regretting their casual approach.

Most importantly, it reveals franchisees have neglected to seek independent expert advice from accountants and lawyers when conducting their research or due diligence.

The report is the second phase of a 12 month joint research project by the Asia-Pacific Centre for Franchising Excellence at Griffith University and the University of New South Wales.

According to the authors, “many business owners were unfamiliar with the term ‘due diligence’ or with how to conduct effective due diligence”.

In fact just 13 percent of current franchisees indicated they had a clear understanding, while 11 percent had never heard the term due diligence.

The report also found that, with a few exceptions, research on business opportunities conducted by franchise buyers was “relatively unsophisticated”.

However those franchise buyers who are undertaking due diligence are investing more on the cost than are independent small business owners.

So what advice are franchise buyers seeking?

Most commonly franchise buyers consult friends and family (36 percent) with legal and financial advice almost as frequent (35 percent).

Desktop research was conducted by 41 percent of current franchisees while 24 percent posted questions on a blog.

Just 38 percent of current franchisees spoke to other franchisees and even fewer visited other franchisees in the network (31 percent).

It’s a concern that 54 percent of respondents either sourced free legal advice or avoided consulting a lawyer altogether, and almost 40 percent avoided paying accountancy fees.

And the research found that though some franchisees are heeding franchisors’ directives to seek independent advice, the sums quoted would not allow for detailed feedback. Current franchisees, however, had spent more on due diligence than had independent business owners.

The average spend on due diligence for existing franchisees was $2,500 while independents invested only $1,500.

As the authors write, “this low spend on pre purchase professional advice while conducting due diligence implies a rather cavalier approach to understanding and managing financial and business risk”.

Franchisees tended to spend more time investigating the business with the franchisor than conducting independent research.

Sixty nine percent of current franchisees believed they would have benefited from doing further research before buying the business.

The rather casual approach is revealed again with 50 percent of franchisees admitting they overlooked information or advice because of their determination to go ahead with the purchase. Their possible reliance on the turnkey opportunity and relevant support might be misplaced, suggests the report, referencing previous research that indicates 34 percent of franchisors began franchising in the first 12 months of their business operation.

When it comes to information received, more than half (56 percent) of current franchisees believed they had information withheld, and 50 percent believed information received had been misleading.

“This result suggests that much more can be done to ensure that prospective franchisees enter these relationships with accurate perceptions, derived from full, accurate and properly contextualised information," suggest the report authors.

So what should you do?

Enrol in a free, online pre-entry education course at Griffith University that gives a good overview of how franchising works. It's funded by the Australian Competition and Consumer Commission.

It’s always good to consult with friends and family, particularly if they have an accounting or legal background, but it can be hard for them to be objective. There is more merit in consulting external advisers – accountants, lawyers, financial advisers.

The Franchising Code of Conduct expressly states: ‘You should get independent legal, accounting and business advice before signing the franchise agreement’.

Most importantly, seek advice from professionals who are experienced in the franchise sector.

Use the information provided by the franchisor as the basis for your research but do not rely on it.

Find out all the facts you can about the business and its directors.

Turn to franchisees (both existing and former) in the network to seek their views.

Spend time working in the business if you can, before you sign up to a franchise agreement.

Read the franchise agreement and the disclosure document yourself – and get your lawyer to go through all the documents.

Take your time.