Buying a Franchise – Finding a Goldmine and Avoiding a Sinkhole

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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 franchised business.

But wait one second – it is not that simple! Even in the well-known giant franchise networks, there have been some real commercial horror stories of bankrupting franchisees. The baseline is to remember this question – why would a big 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 that 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, a franchisee can cream a fantastic profit in an excellent location. Before buying a franchise, a prospective franchisee should calculate its investment costs to reflect both potential scenarios. Still, you have to do in-depth research and much gossip to make sure you are not sinking more into the franchise than is justified by the revenue streams 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 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;
• The 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 must give you a copy of the Franchising Code and the documents and commercial information (‘disclosure document’) which the Code specifies and a final version of the franchise agreement. They have to do at least 14 days before any papers are signed or money handed over. When you look at the information, you need to make your own enquiries regarding business conditions 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. 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 contract? Think twice if you don’t because you could be left in the cold. Even when you 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 to another outlet? 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. Do the franchise’s third-party suppliers require you to charge much the same or higher prices than 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 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?

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 offer the lawyer certificate upon our review of the proposed franchise agreement.

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

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