Take your time when it comes to due diligence
Dr Michael Schaper, deputy chair of the ACCC, looks at the process of due diligence and how long it should take.
We’ve all heard the tales of cashed-up franchisees who, swept away by enthusiasm for a brand and a system they feel is just right for them, buy a franchise in just a few weeks. While these franchisees could be lucky and end up with a great investment, rushing to commit is a risky process.
Buying a franchise is a big decision that requires a good deal of thought and research. Due diligence—the process of carefully analysing the practical, financial and legal aspects of a franchise agreement before you commit to it—is a critical part. It’s important to dedicate time to this process in order to reduce the risk of facing problems down the road.
What steps should I take?
While different people will devote different amounts of time to researching an investment opportunity before making a decision, every prospective franchisee should take the following steps before buying a franchise:
1. Do a franchising education program
Even if you’ve owned a small business before, you might not know all the ins and outs of franchising. Before you start researching any particular franchise system, it’s worth finding out how franchising works by enrolling in a franchising education program. Griffith University offers a free online program, funded by the ACCC, which is available at http://www.franchise.edu.au/pre-entry-franchise-education.html.
2. Decide whether franchising is for you and, if so, what type of franchise
Assess whether you are suited to franchising. If you like doing things your own way, you might feel overly restricted if your franchisor controls your marketing activities or tells you what stock to buy.
If you are pretty sure that franchising is for you, consider the type of franchise that would match your personal attributes, including your education, skills, experience and lifestyle. If you don’T like being outside, a mowing franchise might not be the right choice for you!
Also consider whether you can devote the necessary hours to the franchise in addition to your family and other life commitments.
3. Read all relevant documents
Under the mandatory Franchising Code of Conduct, a franchisor must give you a disclosure document, a final copy of your franchise agreement and a copy of the code at least 14 days before you sign an agreement or hand over any non-refundable cash.
The disclosure document contains important information about the franchise, including the payments you’ll be required to make and what will happen when your agreement ends. It also sets out the contact details of all current franchisees and some past franchisees.
The franchise agreement is the binding contract that sets out your rights and obligations and those of the franchisor. It is critical that you read and understand these documents.
4. Get independent professional advice
Under the Franchising Code, you must sign a statement that you have received advice from a lawyer, accountant and business advisor or that you decided not to seek this advice. While you don’t have to get advice, it is a bad idea to skip this step.
Ask your lawyer to have a look at the franchise agreement and highlight any clauses that raise concerns. Talk to your accountant about whether any earnings figures the franchisor has given you are realistic, whether you are likely to recoup your investment (with a reasonable return) within the term of the agreement and whether you can afford the risk of the franchise failing.
5. Talk to other franchisees
Contact as many current and past franchisees as possible – and not just those recommended by the franchisor. Ask current franchisees about their experience with the franchisor, whether they are happy with their earnings and whether they would buy their franchise again if they could go back in time. Ask former franchisees why they left the system.
How long should due diligence take?
Due diligence is not simply a list of tasks you have to tick off before signing an agreement—it is a process that should continue until you are comfortable that you are making a fully-informed decision.
The amount of time that due diligence takes will be different in each case. While the Franchising Code prevents you from buying a franchise unless you’ve had at least 14 days to read the disclosure document and franchise agreement, this doesn’t mean that 14 days is enough time to undertake adequate due diligence. It will take time to find experienced professional advisors, and for them to provide advice. Current franchisees may be busy, and you might not get a chance to speak to them for some time.
So give yourself at least three or four weeks to cover all the issues.Don’t feel rushed into signing anything or paying any money. If a franchisor is pressuring you to pay money or sign an agreement before you have done your due diligence, treat this as a warning sign.
Can't I just rely on my cooling offer period?
While the Franchising Code gives franchisees a seven day cooling off period, you can’t rely on this to protect you from a failure to undertake due diligence. If due diligence is not completed, any problems are unlikely to come to light within the first seven days. It may be months or even years before the issues are discovered.
Remember, there is no protection for simply entering into a bad agreement, so make the time to undertake thorough due diligence.
- The ACCC has several franchising publications containing useful information for prospective franchisees, including a Franchisee Manual and a DVD about the Franchising Code. These are available at www.accc.gov.au/franchising or by calling the ACCC’s Small Business Helpline on 1300 302 021.