The recent Franchising Inquiry Report, referring to 2018 research by IBISWorld, noted that franchising has expanded across several industries, including many different service industries such as administration and support services, rental and hire services, education and training services, finance and insurance services, construction and trade services, information media and telecommunications services. They can include a wide variety of business services models and concepts, such as cleaning, couriers, bookkeeping, accounting, mortgage and business brokers, strata management, printing and copying, recruitment and HR services, appliance testing and drug testing.
With some of the difficulties currently facing many retail franchised businesses, franchises that offer services to other businesses may be an alternative. However, if you are considering buying a business services franchise, in addition to your usual due diligence ensure that you carefully consider the issues set out below.
Territorial rights and limitations on exclusivity
It is important to be clear about whether or not you will be granted a geographical territory. If so, make sure you know whether the territory is exclusive or if other franchisees or the franchisor may be competing with you in the territory. Most franchise agreements place limitations on exclusivity, and in some the territory will be non-exclusive. Often the franchisor will be responsible for referring clients to franchisees. Your franchise agreement might provide you with a first right to service clients in a geographical area.
Client contracts
The nature of business services franchising lends itself to longer-term relationships with clients and may work on the basis of fixed-term contracts. There are a number of issues to consider in relation to such contracts.
When considering the value of such contracts, take into account the length of the contract and the rights of the client to cancel or terminate the contract. Ask to see a copy of a sample contract.
Franchisors will sometimes offer, or even guarantee, that they will provide franchisees a certain quantity of work. However, if the contracts can be terminated by the client easily or on short notice, the true value of the contracts may be less than is initially apparent. If a contract is terminated or not renewed, does the franchisor have an obligation to offer you another contract, or are you responsible for finding your own replacement?
Often client contracts will be made between the franchisor and the client, not between the franchisee and the client. Although this has its advantages, there may be disadvantages in terms of lack of control by franchisees.
When you are referred clients on fixed contracts by the franchisor you may not have the opportunity to negotiate the contract – the price may have already have been determined. If so, the price should be based upon a realistic assessment as to how long and how many people it will take to provide the service. If the job takes longer than anticipated or if more staff are required, the contract may not be as profitable as expected. As part of your pre-purchase and ongoing due diligence you need to make your own assessment to ensure each contract can be realistically completed for the price being paid by the client. You should ask for copies of each contract.
Often franchisors are responsible for invoicing and chasing debts from clients. You need to have a clear understanding of the implications for you if a client does not pay or pays late.
Fees
Most franchise agreements require the payment of both upfront fees and ongoing royalties (amongst other fees). Royalties are usually structured as a monthly or weekly flat fee or as a percentage of turnover. Upfront fees are sometimes based upon a certain value of client contracts, whereby you can purchase different levels depending on the amount of work you want. This can be an advantage, because if you only want to work a few hours a week, a lower initial investment can help get you started. However, it is very important to understand what you are getting for the amount that you’re paying, how you go about upgrading to another level, and what happens to your investment if you wish to downgrade.
You should also ask about what happens if a client terminates or does not renew its contract and what implications this will have for royalties or other fees that you are paying the franchisor.
Transfer
There are obvious advantages to purchasing a business with existing clients. However, given the longer-term nature of business services, the clients’ loyalty to the existing franchisee may make it difficult for you to take over as service provider. Ensure the vendor of the business undertakes a process of handover and client referral so the clients will be comfortable with you. Also consider how the outgoing franchisee should be restrained from competing against you.
End of term and restraints
At the end of the term, the franchise agreement may prevent you from providing similar services for a certain period of time, either in the geographical area that you have worked in and/or to businesses to which you have provided services. This is an issue that you should consider before purchasing the franchise. If you have provided similar services in the industry before you became a franchisee, then you need to negotiate changes to any clause in the franchise agreement that limits your ability to continue doing so at the end of your term. Similarly, if you introduced your own pre-existing clients to the franchised business, you should not agree to being restricted from serving them after the end of the franchise agreement.
Get help to make the right decision
Purchasing any type of franchise is not a decision to be made lightly. However, with business services franchises, there are particularly complex issues that may arise because of the nature of longer-term contracts. These are just a few of the issues that must be considered in depth. It is critical that you take your time to undertake sufficient research and consider all your options as well as the risks.
The research process can be daunting and overwhelming. However, you don’t have to do it all alone – help is available. To learn more about franchising, there is a significant amount of valuable information available for free from reputable sources including www.accc.gov.au. There is no substitute for thoroughly reading all the key documents, including the franchise agreement and disclosure document, yourself. Once you’ve done that, you will be in a better position to ask questions of the franchisor, as well as former and existing franchisees.
Before making your decision, it is vital that you seek advice from accountants, lawyers and business advisers who are experienced in franchising. Once you have taken these basic steps, you are better placed to understand your options and risks, and you will be heading towards making the right decision for you.
Louise Wolf is a Senior Associate working within the Corporate Advisory and Franchising Team at MST Lawyers. She advises franchisees and franchisors in relation to franchising, intellectual property and privacy. You can contact her at (03) 8540 0273 or (03) 8540 0200.