Buying a Franchise – things you should know
Buying or starting a business can be overwhelming. There is a lot to consider – the most suitable structure for your business, the financial and taxation implications and ensuring from the start that you are placed in the best position for future growth and profitability.
A franchise is a popular choice when looking at business opportunities. The good reputation of the product or service has already been established and there are usually several franchise outlets that appear to be doing well, supported by strong marketing campaigns.
Following are some of the things you need to know before committing hard-earned funds and time to your new venture.
What is a franchise?
A franchise is a business system comprising a licensed Trade Mark or brand, established processes and (ideally) the necessary support to make the business successful.
The franchisee buys a licence to operate the franchise system through their own business entity but under the ‘umbrella’ of the head franchisor. The licence includes access to standard procedures and training, administrative systems and marketing plans.
Due to the nature of a franchise, the business operations are confined within an existing structure. This is an important consideration. This structure can provide direction and certainty to a new business owner, however some entrepreneurs may find this restrictive and should think carefully before committing.
Franchise agreements are regulated by the Competition and Consumer (Industry Codes – Franchising) Regulation 2014 and the Franchising Code of Conduct (the ‘Code’). The Code is mandatory and sets out the documentation and processes required when buying and selling a franchise. It contains important protections for the franchisee.
Disclosure documents and the franchise terms
The Code provides that a disclosure document must be given to a prospective franchisee at least fourteen days before a franchise agreement is entered into or a deposit paid. The franchise agreement must be attached to the disclosure document.
Sometimes a draft disclosure document and franchise agreement are provided first and later replaced with final versions. However, if negotiations have been ongoing, the disclosure document and franchise agreement may be in final form. It is important that anything that has been verbally agreed to is included in the final agreement.
The disclosure document contains details of current and former franchisees, providing an opportunity to discuss the franchise with others. This may enlighten you to issues that would not be discovered during negotiations with the franchisor.
The franchise agreement will cover a range of matters such as the term of the agreement, franchise fees, the territory, confidentiality and protection of intellectual property, training and recruitment processes, supplier arrangements, product pricing, advertising and marketing, options for renewal, competition and restraint.
Franchise agreements usually include terms protecting the franchisor from claims if the business or proposed location is unsuitable or the franchise unprofitable. The franchise agreement will likely have strict provisions preventing unauthorised use of intellectual property such as Trade Marks, logos, recordings and images. Such clauses recognise the franchisor’s efforts to preserve the value of the brand.
The agreement should set out clearly the franchisor’s training obligations and ongoing assistance. These should be comprehensive and cover all areas of managing your new venture.
Your lawyer will review the franchise agreement to ensure that the terms are reasonable. The agreement must comply with the Code and not contain prohibited clauses such as refusing a franchisee’s reasonable request to transfer the franchise, requiring the franchisee to sign a general wavier of liability or waivers regarding written or verbal representations.
Incidental legal documents
There will usually be several other documents relating to your franchise business such as an operations manual, a confidentiality agreement with respect to intellectual property, loan documents, retail leases, equipment leases and supply agreements.
The documents should be reviewed separately and the interplay between each assessed within the overall business structure.
A retail or commercial lease may be fundamental to running the franchise and sometimes the franchisor will offer assistance with lease negotiations. The duration of any lease should be carefully reviewed to ensure that it coincides with the terms of your franchise agreement, taking into account options for renewal.
How much will it really cost?
You should review the entire business structure to ensure that all costs are included in your financial planning. In addition to the obvious costs such as the initial franchise fee and lease payments, there will be ongoing franchise fees (royalties), advertising and marketing fees, fit out fees (if applicable), staff wages, approvals (if required), accounting and legal fees.
Generally, ongoing franchise and advertising fees are calculated based on a percentage of sales. These should be clearly explained to you and reflected accurately in the legal documents.
What happens at the end of the franchise agreement?
It is important to remember that the franchise agreement does not run indefinitely – the term of the licence to operate the franchise will be set out in the agreement, usually with an option to renew for a further term.
All agreements should include an option to renew otherwise the franchisor is under no obligation to enter into a further agreement when the initial one expires. Agreements with renewal options will provide a specific timeframe for you to exercise (give notice) of your decision to renew the agreement. If you miss this timeframe, then the option is lost.
Be aware also that a renewal agreement may not contain the same terms as the original franchise agreement however significant changes may be limited by including appropriate provisions in the original franchise agreement.
Your plans should contemplate various scenarios and account for the unexpected such as an unforeseen need to end the franchise term early.
Restraint of trade clauses should also be considered – these are generally enforceable in a franchise agreement if properly drafted and reasonable.
It is easy to let ‘brand power’ influence your decision-making when looking at a franchise opportunity. Remember though, a franchise is a unique business structure and should be carefully considered and understood before a decision to purchase is made. There is a lot at stake, and it would be unwise to proceed before obtaining sound advice from your accountant and legal advisor.