Buying a franchise? If it doesn’t add up, don’t sign up.
Buying a franchise? If it doesn’t add up, don’t sign up.
If you’re buying a franchise – particularly for the first time – getting a complete understanding of the start-up and operating costs is essential.
The Australian Competition and Consumer Commission (ACCC) is responsible for regulating the Franchising Code of Conduct and provides guidance to prospective franchisees. The Franchising Code requires franchisors to give current information about the franchise, including start-up and running costs, to people thinking about buying a franchise. This information must be given regardless of whether it encourages the person to buy.
We receive about 400 complaints each year about franchising, and many of these are from franchisees. The following is a hypothetical case study that highlights some of the common complaints reported to us.
‘They told us it wouldn’t cost more than $350,000 to open the cafe, but it ended up costing $450,000. They said it was because of an improvement to the fit out and the equipment. We’d mortgaged our home and borrowed as much as we could to get the $350,000. When we needed more money, the bank wouldn’t extend the loan. So we borrowed from family members, just to get the cafe open. We knew we’d lose our money if we pulled out at that stage.
We were told there would be some restrictions on who could supply things like the fit out of the cafe, the equipment and the point-of-sale system. But it also turned out that we couldn’t choose where to buy basic things like milk, bread, coffee and soft drink. We even had to buy sandwich fillings from their supplier. And their suppliers charged too much – we could buy those things cheaper at the supermarket. Then we found out that some of the suppliers pay money to the franchisor every time we purchase from them. No wonder they are so expensive. We feel trapped.’
As part of our role, the ACCC conducts targeted compliance checks of franchise systems. Our current compliance checks are focused on the food services industry, because we receive more complaints about franchise businesses in this industry than any other.
Through our compliance checks we are checking:
- Whether prospective franchisees are properly informed before they sign a franchise agreement, in situations where they can only buy certain goods or services from suppliers specified by the franchisor.
- Whether prospective franchisees are properly informed about any rebates or benefits a franchisor gets when franchisees buy from specified suppliers.
- Whether prospective franchisees are properly informed before they sign a franchisee agreement about the true costs of setting up and operating the franchise.
- Whether or not the disclosure document lists the contact details of current and former franchisees in enough detail to allow someone thinking of buying a franchise to make contact and ask questions.
- If a person is buying a franchise within an existing site or territory, whether the details about the circumstances in which former franchisees ceased to operate have been provided to them.
Incomplete or inaccurate information, or a poor understanding of costs and supply restrictions, could lead to franchisees becoming financially stretched and put their investment and livelihoods at risk. It could also lead to a franchisor facing accusations of breaching the Franchising Code and the Australian Consumer Law.
Understanding the disclosure document
Important information like the cost of setting up and running a franchise, or whether a franchisee can only buy goods from specified suppliers, should be in every disclosure document. A disclosure document is a mandatory document that must be provided by franchisors to prospective franchisees before they enter into a franchise agreement.
The franchise agreement must also be provided in signable form, together with a copy of the Code, at least 14 days before a franchise agreement is entered into by a prospective franchisee. If you have not already done so, you can use this time to consider whether to negotiate any changes to the franchise agreement.
It is essential to take the time to read these documents thoroughly. Remember, 14 days is the minimum time that franchisees have to read, understand and get professional advice about these documents, not the maximum time.
While all disclosure documents in Australia must follow a prescribed format set out in the Franchising Code, the detail in the disclosure document will be specific to the franchise. Outlined below are two important parts of a disclosure document. This list is not comprehensive, and you should always seek independent professional advice about your individual situation.
Item 10 – supply restrictions and rebates
In a disclosure document, Item 10 focuses on the supply of goods and services to a franchisee.
Item 10.1(b) of a disclosure document requires franchisors to provide details of restrictions on purchases of goods or services by the franchisee. This is relevant to franchise businesses in which franchisees are only allowed to purchase certain goods or services from specified suppliers. For example, if you are involved in a coffee shop franchise and you are only allowed to buy beans from one supplier. This can be critical to the success of a business, because it means if these coffee beans are expensive, you can’t shop around for a better deal.
Items 10.1(j) and (k) of the disclosure document require the franchisor to give details of whether it, or its associate, will receive a rebate or financial benefit when franchisees purchase goods or services from a specified supplier. The franchisor must provide the name of the supplier, and state whether the rebate or financial benefit is to be shared with franchisees. It is our view that the types of goods and services should also be listed with the name of the supplier, to make this information meaningful for the franchisee. If not provided, ask for details about what goods and services are to be purchased from suppliers who provide rebates to the franchisor. It is important to understand whether restrictions on your choice of supplier could have a negative effect on your bottom line.
Item 14 – costs of setting up and operating a franchise
Item 14 provides details about the costs and expenses that may be payable by a franchisee to set up and operate the franchised business. These costs can be significant and can vary based on things such as your turnover. It is important to fully understand these costs, because if you cannot meet them you may inadvertently breach your franchise agreement.
Item 14.3 requires the franchisor to specify the costs and expenses of establishing a franchised businesses. In the case study above, the disclosure document should have been updated to include the price ranges of the fit out and equipment.
Items 14.6 and 14.7 require the franchisor to specify the costs and expenses of operating the business on an ongoing basis. Be sure to test all figures set out in Item 14, and do your own calculation of staff wages using the correct award wages. You can find these on the Fair Work Ombudsman website. Ensure you can afford to pay your staff and yourself. Calculate your staff wages using the correct award rates from the Fair Work Ombudsman website. Ensure you can afford to pay your staff and yourself.
After reading Item 14 and making your own calculations, you can then ask past and current franchisees about whether estimates they were given before signing matched up in reality.
Informing yourself about the risks
If you are thinking about buying a franchise there are four key things you should do to assess risk. These are:
- Read and understand your disclosure document and franchise agreement
- Talk to current and former franchisees
- Take your time
- Get independent professional advice.
Obtaining independent advice from a professional with experience in franchising is vital. We still find that too many franchisees fail to get any independent advice. Accounting and/or business advice is particularly important to help you understand the costs of starting and running the franchise, and the impact of any supply restrictions or rebates.
After you’ve obtained advice, remember: if it doesn’t add up, don’t sign up.The information in this article is for guidance purposes only and does not constitute or substitute for legal advice. When considering a franchise opportunity, seek advice from a lawyer, accountant and business advisor with franchising expertise.
The Australian Competition and Consumer Commission (ACCC) is an independent Commonwealth statutory authority whose role is to enforce the Competition and Consumer Act 2010 and a range of additional legislation, promoting competition, fair trading and regulating national infrastructure for the benefit of all Australians.
Mick Keogh was appointed as Commissioner of the ACCC in 2016, and then as Deputy Chair in 2018. His role at the ACCC includes involvement in a range of committees, as well as oversight of the small business, franchising and agriculture units of the ACCC.