Entering a franchise is a significant investment, so it’s essential to do your homework. Australian franchises are required to provide prospective franchisees with a Franchise Disclosure Document. In New Zealand there is no such requirement, however some franchises voluntarily provide the same type of information. For simplicity’s sake, I’ll refer to Franchise Information as a catch-all for the Franchise Disclosure Document but also for any information you can gather from a franchisor when you’re considering a franchise investment.
Carefully analysing all of the Franchise Information you can obtain is absolutely critical, in fact it may be the most important homework assignment you’ll ever do. So, let’s dive right in:
- Franchisor’s Background and Business Experience
Even with well-known franchise networks, it pays to look closely at the history of the business, and at the experience of the leadership team. Understanding where the business has come from can provide you with valuable insights into where it may be going, and you’re tying your future to the vision set by the leadership team, so make sure that vision (and their values) align with yours.
Look for key information about:
- The franchise’s success, reputation, and industry standing.
- How long the franchisor has operated and whether they have any litigation history.
Understanding the franchisor’s experience is key to assessing the business’s credibility. If the franchisor has had legal troubles, it could indicate risk but it’s up to you to determine if they’re true red flags or just the bumps and bruises of corporate life.
- Fees and Financial Obligations
Amongst your Franchise Information you’ll find that all important information about the fees you’ll be expected to pay, and the costs associated with starting your business. These typically include:
- The initial Franchise Fee that you’ll pay to join the franchise network.
- Your Ongoing Fees, including royalty fees, marketing contributions, and technology fees, often based on revenue percentages.
- The initial capital requirements such as costs for setting up, equipment, supplies, and other operational essentials. As well as your working capital requirements.
It’s important to ensure you understand both the initial and recurring costs, which can significantly affect your profitability and return on investment.
- Franchise System and Support
The Franchise Information should provide you with a clear outline of the franchise system, including how the business operates and the support you can expect to receive. You’ll should make sure you’re clear on:
- The initial, and any ongoing, training requirements.
- What manuals, policies, and procedures will be provided to guide you in the running of your business and to ensure you can maintain consistency with the network.
- Details of the support services. What marketing, technology, mentorship, or other business support services are offered to franchisees.
Not having to invent new wheels is one of the big attractions of buying into a franchise. You want to ensure that the franchisor is going to provide you with all the necessary tools to help you succeed in your new business venture.
- Territory Rights and Restrictions
Franchises are often defined by exclusive rights to particular geographic areas, so you’ll want to be clear on how your territory is defined.
- The first question is, do you have exclusive rights to a particular area, or could the franchisor allow other franchisees nearby?
- Is there any first right refusal around opportunities to open additional units in neighbouring territories.
Knowing your competitive landscape and expansion opportunities is important for protecting your investment and assessing future growth potential.
- Look at financial forecasts or earnings projections
Some franchisors may provide forecasts or guidance around expected financial performance. If this information is provided it should be supported by some clear evidence and not just vague promises. Remember that forecasts are often just ‘typical’ examples or averages.
- Ask about the assumptions that underpin any figures that are provided.
- Tailor the forecast to your specific circumstances, don’t just take the average but look for real-world comparisons.
Most of all be cautious of inflated projections, instead where possible talk to existing franchisees about real-world performance data.
- Renewal, Transfer, and Termination Terms
Franchise agreements typically have a limited term, after which there will be options around renewal or termination. It also pays to understand how things work if you need to sell or transfer your franchise.
- Check the details around how long the franchise agreement lasts and under what conditions it can be renewed.
- What are your obligations if you choose to leave the network? Does the franchisor have any right of refusal to repurchase the business?
- What are the circumstances that might give rise to a termination of the agreement? Are there any penalties that apply?
While you’re looking at terms you should also check for any obligations to refurbish physical sites after a set amount of time. It’s common practice for a spruce up to be required every five years or so.
- Dispute Resolution
We all want to go into business thinking things will work out, but disputes between franchisors and franchisees can occur. Take a look into the procedures for resolving disputes, is there an established process of mediation or arbitration? If you’re looking at contracts check out the legal jurisdiction that applies.
Given the potential for complex (and consequently expensive) legal matters, it’s a good idea to have a clear dispute resolution process just in case things go wrong.
- Current and Former Franchisees
Hopefully the Franchise Information will provide you with some contact details for current and former franchisees, allowing you to conduct due diligence by:
- Talking to existing franchisees about their experience, challenges, profitability, and support received from the franchisor.
- Looking at franchisee turnover, terminations, or repurchases: A high turnover rate could indicate dissatisfaction within the system but make sure you consider numbers in the context of the overall network size.
Speaking with existing (and past) franchisees is often the best way to get an unvarnished view of the franchise.
In Conclusion
Understanding all the Franchise Information you can get your hands on is key to making an informed investment in a franchise business. Take your time and be thorough in evaluating each aspect of all the information provided. If there’s critical information that’s missing or not available to you, ask why.
Once you think you have a clear picture, check with your legal and financial advisors, and of course talk to existing franchisees to make sure your understanding is correct. Remember, the aim is to avoid any nasty surprises, and the better the due diligence you perform, the more confidently you can enter into a franchise relationship and set yourself up for success.
About the Author
Phil Chaplin the Chief Executive Officer of the CFI Finance Group, a specialist finance company servicing the franchise, accommodation, and fitness sectors as well as small businesses more broadly cross Australia and New Zealand.
Phil has over 20 years’ experience in providing finance to businesses across Australia and New Zealand and has managed finance companies in the private and banking sectors, he is a former chair of the Equipment Finance division of AFIA.