Don't confuse Due Diligence with Business Advice
This article appears in the Jan/Feb 2016 issue of Business Franchise Australia & New Zealand
The most common complaint I hear from franchisees who are struggling is that they wish they had done more due diligence before buying into the system.
But what is due diligence? It is more than just seeing the professionals. It is research that you do yourself that educates you on the system you are buying into.
Before you can enter a franchise agreement it is a legal requirement that the franchisor gain from you, a signed document that states you have had advice from a lawyer, an accountant and a business advisor. Signing this form does not ensure that you have done your due diligence. All the form guarantees is that you have received advice. Advice and due diligence are two very different things. In fact, visiting your professionals should be the last step in your due diligence process. Let me show you how to ensure that you are completing thorough due diligence.
There are three main areas that you need to research before you set foot in the professionals’ office for their advice. These are:
1. You - your skills, abilities and drive;
2. The franchisor - their systems, processes and business model; and
3. The business case on offer to you from your chosen franchisor.
LET ’S TALK ABOUT ‘YOU’
Not everyone is suited to own and operate a franchise. When buying a franchise you are making not only a big investment but also you will be tied into agreements for a very long time. You have to be sure that franchising is a fit for you.
Franchising is basically a system that you, as the franchisee will be required to follow, so ask yourself, “Can I follow instructions?” and “Do I stick to the rules?”. If you answered no to both these questions then franchising is not for you. The main reason I suspect that you are buying a franchise is because of the system so it is imperative that you follow it.
How are you at communicating and relationship building? Again franchising requires that you communicate well with both your franchisor and the support staff that are there to help you. You need to be able to build a relationship with the support staff and sometimes this has to happen in the most volatile of situations. After all, you have risked much to invest in the system; you are the one who stands to lose financially if you walk away.
What skills do you have that will help you to run a business? The franchisor will guide you on how to best operate the system you are buying into, but you need other skills, business skills for example. The franchisor is not responsible for training you in this area.
You will most likely become an employer. Do you have these skills? If not, do you have someone in your network to help you gain these skills? How are your bookkeeping skills? You have to keep very detailed records of invoices, through to payment of suppliers and then onto submission of business activity statements to the ATO. Can you do this or will you need a bookkeeper in your team? There is no doubt that you can gain these skills, but it makes sense to start acquiring these skills now before you buy your franchise. Once you become a franchisee you are very busy running your business and you may not have the time you need to undertake any additional courses.
CHOOSING THE RIGHT FRANCHISE SYSTEM
Now that you have decided that you do want to buy a franchise, let’s look at step two of the due diligence process: how to choose the right franchise system for you.
Firstly, you have to define your ‘WHY’. Why do you want to buy a franchise? Is it because you would like independence, freedom from the 9–5, flexibility in the working day, or do you want to build your own empire? Whatever it is, be very clear because it will help you to choose the right franchise system for you; one that is profitable; one that you can work in and one that you are proud to be a part of.
Now you have to look at how much you want to invest together with how you will fund your purchase.
There are four main ways that people fund the purchase of their franchise.
• Equity in assets
• Access to franchisors’ accredited lenders
• Or a combination of all of the above.
Once you know why you want to buy a franchise and how you are going to fund it, you should apply to the franchise systems that interest you. Research more than one system. Remember you are going to be working in this system for quite some time, you have to be a perfect fit for their product and their brand.
When you are researching your franchisor, you will need to pay a lot of attention to their business model. How does it work? How profitable is it? And what do other franchisees think of both the franchisor and the system they are working in? Are they making money? A perfect question to ask any franchisee in the system is, “Would you buy another store in the system?” I would also track down past franchisees of the system and find out why they are no longer in the system. All franchisee contact information will be in the disclosure document that the potential franchisor will give you. All you have to do is contact them.
So onto step three, the business case you are offered by the franchisor. You are happy that you want to be a franchisee, you have found the franchise system for you, be sure you get the profitable opportunity within the system.
By the time you have got to this stage you have probably already signed a confidentiality agreement and made a formal application to the system. The franchisor has approved you but be sure that you have not signed the franchise agreement yet. Once you do, you only have a seven day cooling off period within which to complete this next step and visit all your professionals.
When you are analysing your business case on offer you will need to research all these areas:
1. Lease and/or property you are buying;
2. Conditions of the lease and contract of sale;
3. Equipment: what are you buying? how does it work? will you need to buy more? and
4. Staffing requirements.
It is essential that you prepare a budget and prepare three scenarios; one for a high sale volume, a mid range sale volume and a low sale volume. Be sure to estimate your expenses correctly by speaking with not only the franchisor but franchisees in the system. Once you arrived at the bottom line of the budget be sure you are happy with the profitability. From this budget identify the key performance indicators (KPI’s) you will need to meet from day one of operation in your new business.
Once you have the budget, you need to prepare a business plan that not only addresses how you will enter the business, but also how you will exit it. Incorporate how you will fund your business and how soon you will repay your loan or embark upon multi-siting within the brand. This business plan will outline your whole franchising journey. It is quite reasonable to research many opportunities before you find the right one within the system you want to invest in.
THE FINAL STEP
Now onto the final step in your due diligence process. Once you have found the right opportunity with the right franchisor, it is time to take all your documents to your professionals.
Your lawyer will help you to analyse the franchise agreement, the disclosure document, the lease or property purchase as well as go through any other agreements you may need such as employment agreements or licenses to operate.
Your accountant will go over your budget and business plan with you and advise on the best asset protection vehicle for you. You might at this point visit a finance broker to source the best funding deal for you.
Now is also the time to set up the relationship with a business advisor. Someone who will help you to implement the systems and processes that you have bought from the franchisor. This advisor should also mentor you to be sure that you hit the KPI’s you identified in your budget, to ensure that you reach the profit levels you were after. Sometimes having this business advisor on board from the beginning secures a cheaper interest rate from the lender so it is a service that pays for itself.
Remember your franchisor is not your business advisor. If you buy into their system you will be a source of income to them so it is hard for a franchisor to remain impartial. It is imperative that you do your own due diligence. I suggest you take as long as you need to do it. Don’t be rushed. Don’t get excited and sign the documents too quickly, do your research.
There are many aspects to consider when buying a franchised business and you, the buyer, are usually rushed along in the process. The franchisor has a time plan and process, the franchise broker can smell the commission so they are in a hurry to make the sale and all too often the prospective franchisee just ends up signing the paperwork in all the rush and bustle and this is potentially where problems can start.
Successful franchisees all have three things in common:
1. they entered their system fully informed.
2. they considered many opportunities before they found the one they were comfortable with. The one that was a fit for them.
3. they entered the system knowing what KPI’s they had to meet from day one to enjoy success in their franchised business.
Remember, buying into a franchise is a huge financial commitment, you can never ask too many questions. You wouldn’t buy a home without a building inspection; you shouldn’t buy a franchise without speaking with a franchisee mentor, someone with your interests at heart.