Franchises – Finding a Goldmine and Avoiding a Sinkhole

If you take a casual look at some franchises, like Maccas or KFC, you might get the impression that they are a licence to print money. Everything decided for you, from product to training to publicity, a well-known brand and logo, access to prime retail addresses, and a Head Office full of lawyers and accountants to assist you. Some people have done very well by successfully running this sort of franchised business.

But just wait one second – it is not that simple! Even in the well-known giant franchise networks, there have been some real commercial horror stories where franchisees have been bankrupted. The baseline is to remember this question – why would a giant corporation offer franchisees a chance to dip into their vast profit-streams if they could make the same or better profits by just running their huge business the old-fashioned way from Head Office?

The answer is that offering franchises spreads the risk which giant corporations get into as their operations become bigger and bigger and, therefore, more difficult to run from Head Office. A franchisee in a less ideal location will keep the corporate flag flying there while not risking corporate profit as much as if it were a directly owned outlet.

On the upside, in an excellent location, a franchisee can cream a fantastic profit. Both situations should be reflected in the franchisee’s investment cost. Still, you have to do in-depth research, and quite a lot of gossiping, to make sure you are not sinking more into the franchise than is justified by the revenue-streams which you will realistically get.

What’s the latest from the Federal Government since its franchising inquiry?

In 2019, a parliamentary committee sat and listened to evidence about franchising in Australia, a lot of it from unhappy franchisees who felt their franchisors had abused their power in a whole list of ways. The approach of the legislation and the Franchising Code of Conduct has been to require franchisors to be completely open and transparent about terms and conditions. Still, the committee found that nevertheless, there had been significant abuses of franchisees. It released recommendations later in 2019, covering: –

  • Franchisor disclosure of more information on the business and regulation of third-party brokers;
  • Applying cooling-off provisions to franchise transfers, renewal, and extensions, not just to new franchisees;
  • Greater regulation of advertising and marketing levies;
    Greater regulation of supply arrangements and supplier rebates;
  • Improved dispute resolution mechanisms;
  • Fairer exit arrangements;
  • Greater power of the ACCC to intervene in franchising.

After receiving further submissions from stakeholders, the government is expected to propose significant reforms, mainly in favour of franchisees.

So, if you’re thinking about getting a franchise, what should you do?

When you first contact the franchisor (the parent company), they are required to give you a copy of the Franchising Code, as well as the documents and commercial information (‘disclosure document’) which the Code specifies and a final version of the franchise agreement. They have to do all that at least 14 days before any papers are signed or money handed over. When you look at the information, you need to make enquiries of your own regarding business conditions just to be sure you are getting a fair picture from the franchisor. Accounting advice may also be appropriate, and legal advice is a good idea too. Here are some stand-out issues you should consider when reading the proposed franchise agreement-

  1. Do you have the right to renew the agreement at the end of the time laid down in the agreement? If you don’t, think twice, because you could be left in the cold. Even when you do have the right to renew, check what the agreement says about losing that right if the franchisor isn’t happy with you.
  2. If you want to sell the business, what conditions can the franchisor impose on the sale and when can they refuse the sale?
  3. Is your ‘territory’ exclusive, or could the franchisor move another outlet in? Be careful here- sometimes a territory is just what you are not allowed to go outside, or you could have only the right of first refusal on new outlets in that territory. They may also have the right to change the territory boundaries.
  4. What are the fees, other payments, and capital required?
  5. Does the document allow the franchisor to take commissions on third-party suppliers to the franchise business?
  6. Are the third-party suppliers the franchise requires you to use charging much the same or higher prices compared to other suppliers?
  7. Does the franchise require the franchisee to lease or licence premises? If so, who pays for the fit-out, and who owns the fit-out?
  8. What are your obligations under the premises lease or licence?
  9. What is the personal guarantee required? If you don’t want to expose yourself, negotiate the issue with the franchisor and explore alternate security.
  10. What is the level of ‘restraint of trade’? Does it stop you from undertaking any other business at all? Is it only stopping you in one territory, or anywhere? For how long?
  11. What rights does the franchisor have to end the agreement? Would a breach of the operational manual end it? If you were convicted of a crime, would that end it?
  12. What rights (if any) do you have to end the agreement after the cooling-off period?

Sound legal advice will help you get a clear picture of the risks and benefits of the proposed deal

Commonly, a franchisor will require an incoming franchisee to provide a certificate from a lawyer, an accountant and a financial adviser to the franchisee, that that they have each provided advice to the franchisee on the franchise, and we can undoubtedly provide the lawyer certificate upon our review of the proposed franchise agreement.

Contact us on 02 8065 8810 for an initial free no-obligation discussion of your needs in this area.