What is due diligence? 6 things to do before buying a franchise

By Nick Hall | 26 Sep 2018 View comments

There has been a lot of discussion recently regarding the importance of performing due diligence, but as a first-time franchisee, you may be asking yourself, “What does that actually mean?”.

Aside from purchasing a home, starting a business will often prove to be the most expensive investment any Australian can make, and franchise opportunities are no different.

Recent submissions to the parliamentary inquiry into the effectiveness of the Franchising Code of Conduct have placed due diligence or the understanding of fundamental agreement conditions under the microscope.

Regardless of how successful a franchise is, how many stores they have or your own personal connection to the brand, potential franchisees need to know what they are committing to before they decide to enter into a franchise agreement.

Inside Franchise Business has put together this quick guide to ensure first-time franchisees are asking the right questions and looking out for the right answers.

Educate Yourself

In the early stages of the franchise journey, it’s important to take a personal audit of your goals, knowledge and expectations.

Assess your reasons for wanting to own a business, the lifestyle and income implications of owning and operating a business as well as your own understanding of the relationship between franchisor and franchisee.

Not for profit organisations such as FranchiseED were established to help franchisees find independent information and research on franchise best practise, including a range of educational programs to help with the process.

While there is a statutory requirement for disclosure under the Franchising Code of Conduct, franchisors are not required to ensure that franchisees actually undertake due diligence, so it is pivotal that franchisees take on the responsibility.

Regulatory body, the Australian Competition and Consumer Commission (ACCC) has also funded an online pre-entry franchise education program run by Griffith University, providing prospective franchisees with a detailed assessment on whether franchising is right for them.

Consult Network

The most valuable source of information on any franchise system is its existing franchisees.

The people in the system currently live the life of a franchisee and can help explain to prospective franchisees the day-to-day operations and reality of the opportunity.

When considering a franchise business, take the time to visit and speak with a number of current franchisees and ask them about their experiences dealing with the franchisor and any unexpected operational issues.

Some key points to discuss with current franchisees include;

  • The effectiveness of the franchisor’s ongoing support services,
  • How helpful was the franchisor in the initial set-up, construction and design, site selection and financing?
  • Specific strengths and weaknesses of the training program,
  • Franchise specific marketing programs. (Typically, this is the area that most franchisees and unhappy with, so be sure to explore complaints in detail, particularly if similarities arise across sites),
  • Purchasing power, does the franchisor use the collective buying power of the total system to get discounts on supplies and inventory beyond what an independent operator could achieve? Ask for specific examples, both positive and negative,
  • Investment. Use the existing franchisee discussions to narrow down a reasonable and conservative estimate of how much capital the opportunity will require.

While talking in detail about earnings and investment amounts may seem confronting at first, it is important to remember that all existing franchisees were once prospective franchisees at some point.

Analyse Network Growth

The disclosure document will provide insight into the number of franchisees year to year, however, be sure to ask the franchisor to supply additional historical data.

A franchise network that displays steady growth presents a positive opportunity, although one significant indicator of business potential is termination rate.

A high rate of termination could be an indication that while the franchise has a strong recruitment process and program, the business may not be sustainable.

Visit a Franchise Lawyer

Often, the temptation of convenience will find prospective franchisees seeking advice from the local lawyer, however it is imperative that while performing due diligence, franchisees consult a franchise specialist lawyer.

This will provide an understanding of precise legal obligations, as well as any risks or an imbalance of power evident from the documentation governing the franchise relationship.

For example, a franchise lawyer can identify any indemnities and security offered, in addition to ongoing risks, even after the initial franchise relationship has concluded.

Prepare a Business Plan

Consult the disclosure document and asses the franchise fees and expenses presented by the franchisor, both upright and ongoing.

Be sure to run the numbers thoroughly through accountancy software or take the information to a franchise accountant to establish whether the opportunity is profitable moving forward.

Take Your Time

Similar to purchasing a house, there is no expiration date on a business opportunity. Throughout the due diligence process, continue to ask questions, research online, consult advisors and engage with the brand.

One of the best ways to understand a franchise business is through the eyes of a customer, so visit a range of outlets across multiple locations and asses the business operations and systems.

Remember that franchise relationships are long-term agreements, that often range from five to 10 years.

While it may seem tedious, by performing adequate due diligence prior to commencing a franchise purchase, prospective franchisees can save themselves a wealth of time and money should things go sour.