This article appeared in Issue 3#3 (March/April 2009) of Business Franchise Australia & New Zealand
Enthusiasm is an essential ingredient in running a successful business. But like a good wine, too much of it can quickly go to your head and lead to decisions you may later come to regret. Nowhere is this more evident than with first-time entrepreneurs eager to jump into a franchise.
The thud of a hefty disclosure document landing on the desk can come like a wet blanket on top of all that enthusiasm to get started.
But buried in those dense legal documents is the essential information that can tell you if you are about to blow your savings on a shaky business. Decoding that wealth of information can be a daunting proposition for even the most fastidious of people.
So how do you best come to grips with the disclosure material provided ahead of entering a franchising arrangement and what sort of information needs to be included?
All franchisees and prospective franchisees are covered by the mandatory Franchising Code of Conduct, which is part of the Trade Practices Act, administered by the Australian Competition and Consumer Commission.
The Code requires franchisors to provide a range of important information in the form of a disclosure document so that prospective entrants to their business can make an informed decision.
The disclosure document must be in the format prescribed in the Code, and must be provided at least 14 days before any money changes hands or any agreement is signed. The disclosure document includes important information which allows you to easily compare potential franchises.
What information should I receive in my disclosure document?
There is a range of information that franchisors are required to give you in order to help you make an informed decision, including:
- Details of the franchisor’s business experience
- The financial health of the system
- Earnings information does not have to be provided but if the franchisor opts to do so, they must ensure that it has a reasonable basis
- A summary of all fees and other costs you must pay upon entering the system, as well as regular on-going payments
- A detailed list of your obligations and the obligations of the franchisor to you
- Any serious criminal conduct by the franchisor in the past 10 years
- Payments to agents who may have recruited you
- A list detailing the current existing franchisees and the number that have left the system in recent years
- Information on how territories are worked out between franchisees
- Supply arrangements
- Details of any marketing funds that the franchisee may be required to contribute to.
This list is just a start but includes some of the most important information you need to know before committing to a franchise. If the disclosure document does not provide you with sufficient information to gain a clear understanding of the franchise, you should seriously consider an alternative.
There is a shorter form disclosure document which contains less information, and can only be provided where the franchise is expected to turnover less than $50,000 a year. If you receive the short-form document, you can request a long-form disclosure document and the franchisor must provide it.
Assessing the information you have and that you still need
Of course, the best information in the world is only useful if it is used well. The mandatory information provided by your franchisor is a useful starting point, but you need to be aware that there may be important gaps in the information.
For instance, something as simple as a quick internet search of the franchisor’s name may throw up warnings from others who have had a bad experience. There are always two sides to every story, and some people leave franchises simply because they made a poorly informed decision to enter a system in the first place, not because there is anything fundamentally wrong with the business.
However, it is worth arming yourself with all the information possible in order to make the best objective decision possible.
Former and existing franchisees can be one of the greatest sources of information available and you should attempt to speak to as many as possible. Recent changes to the Code make it easier to get the contact details from the franchisor of franchisees that have left the system. Look also at the rate of turnover. If a large number of franchisees are not renewing you should find out why.
When talking to past and present franchisees you need to get indicators of the long term and short term viability of the franchise. Markets change, trends move on and a franchise needs to be able to adapt to those changing market conditions if it is to survive. Discretionary spending by consumers affects many franchises and your market research should take into account how the business is likely to be affected during economic downturns that will inevitably arrive.
Keep in mind that while a franchisor is legally obliged to provide you with a lot of information, they may not necessarily go out of their way to highlight weaknesses in the business.
Therefore, wherever possible, it is wise to seek independent verification of information that is provided by the franchisor.
Reviewing your information
Once you are satisfied that you have filled in any gaps in your knowledge of the business and have as much information as possible, it’s time to begin analysing it.
This is not an exercise that should be attempted alone. You are investing a significant amount of your savings that may well have taken years of hard work to accumulate. You are also relying on the business to be your income to support you and your family. Be prepared to invest a little extra for professional advice specifically from an accountant, lawyer and business adviser with franchising expertise. The network of Business Advisory Centres throughout Australia (www.beca.org.au) is also an excellent resource that can help point you in the right direction during this critical phase of establishing your franchise.
Before you sign your agreement you will have to provide your franchisor with a statement saying you have either sought independent advice or waive your right to do so.
While acknowledging the need for expert assistance, it is also important to remember that the person who ultimately takes responsibility for success or failure is you, the franchisee. For some franchisees it is tempting to leave the hard work to their advisors. This is a mistake. The more you understand your business, the more likely you are to be successful. At the end of the day, if the business turns out not to be viable, it is not your accountant’s home that is potentially on the line.
While it may sound surprising to some, the ACCC regularly hears of unsuccessful franchisees who admit they didn’t bother to read their disclosure documents. Accept that there will be significant research required to make an informed decision.
While you need to familiarise yourself with the entire document, there are particular areas you need to consider:
Does the disclosure document provide details of the earning capacity of the business? Existing franchisees can tell you if the business is as successful as represented in the marketing information. Your accountant will be able to assist you in formulating a business plan using realistic benchmarks.
Does your franchise have exclusive rights to a particular area, or is it possible for another franchisee in the same system to set up close by? If your territory is not exclusive, do you have first rights to refuse another franchise opportunity that opens up in your area?
Are you taking over a site from an exiting franchisee? If so, why did they leave, and how successful were they? These are important questions to ask, and your franchisor must provide franchisees’ contact details. Have you done your market research on the area? What is the likely traffic flow, what demographic do your potential customers fit into, what are their spending habits and what level of competition currently exists in the area or is likely to arrive in the future? You should be able to answer all these questions.
Your franchisor should provide leasing information as part of their disclosure to you. There are a range of different types of leases involved in franchising. In some cases franchisors own sites and lease them to franchisees, in others they sublet space whilst other franchisees lease directly from an independent landlord. Be aware that leasing laws vary between states and territories. Local retail tenancy offices can provide information on the local regulations, and the ACCC also has a factsheet available specifically dealing with leasing issues for franchisees.
Training, support and expansion.
There are good franchisors who recognise that their success ultimately rests on the success of their franchisees, and offer them strong support. Equally, there are franchisors who don’t offer nearly as much support, marketing or encouragement. Find out which category your system falls into. You should have a clear idea of what sort of training, advice and support will be provided, and you should also ensure you have a good relationship with your franchisor, as they will be important to your future success.
The ACCC can provide a wealth of helpful information and has a number of useful publications for prospective franchisees. A good place to start is the Franchisee start-up checklist and the fact sheet Disclosure under the Franchising Code of Conduct. Both are available on-line at www.accc.gov.au or by calling the ACCC small business helpline on 1300 302 021.