FRANCHISING: Know Your Rights

Dr Michael Schaper | Deputy Chair | Australian Competition & Consumer Commission (ACCC)
FRANCHISING: Know Your Rights

FRANCHISING: Know Your Rights

Franchising can be a rewarding investment, providing you with an opportunity to make the most of an existing brand and image. However, it’s important that you go into franchising with your eyes open.

If you decide to buy a franchise you need to know about your rights and protections under the Franchising Code of Conduct (“Code”). The Code regulates the conduct of franchising participants towards each other and is mandatory in Australia. Your rights under the Code include:

  • entitlement to key information about the franchise system which can be found in the franchisor’s disclosure document, that they must give to you;
  • a seven-day cooling-off period for new franchisees;
  • a requirement for ‘good faith behaviour’ by the franchisor (this obligation applies to you also); and
  • access to a dispute resolution mechanism.

The ACCC’s role is to regulate the Code, investigate alleged breaches, and provide information and education to make the franchise experience work better for franchisees and franchisors.

Understand the risks

As with all businesses there are risks with franchising and success isn’t guaranteed for you or the franchisor. This is why it’s important that you do your due diligence to work out if franchising, and a particular opportunity, is right for you. You can assess the risks by following some simple steps:

  • find out what would happen if you, or the franchisor, became insolvent.
  • work out how much capital would be required to establish the franchise and keep you going if you have a slow start.
  • understand the consumer demand for the product or service.
  • ask what will happen at the end of the agreement, and whether you are able to renew, extend or in the event of a sale, transfer the agreement.
  • consider whether the franchise matches your personal attributes, skills, experience and lifestyle.
  • complete a pre-entry franchise education program to find out how franchising works.
  • research the franchise system.

Disclosure document

Under the Code, franchisors are required to provide prospective franchisees with a disclosure document. The disclosure document contains valuable insights about the franchisor, its officers and the franchise system, which will help you to make an informed decision about the opportunity.

Key information you’ll find in your disclosure document includes:

  • relevant business experience of each officer of the franchise;
  • certain legal proceedings against the franchisor, its directors or associates;
  • contact details of current and former franchisees; and
  • whether the franchise is for an exclusive territory.

The franchisor must give you a disclosure document, a copy of the franchise agreement in its final form and a copy of the Code at least 14 days before you enter into the agreement or make any non-refundable payments.

The disclosure document will also contain key financial information to help you work out if a franchise system will be viable for you in the short and long term. When reviewing your disclosure document, it’s worth paying attention to:

  • Start-up costs – the franchisor must outline the range of costs associated with establishing the franchise (such as legal fees and equipment). If a cost can’t be easily worked out, the franchisor must identify the upper or lower limits of the cost.
  • Ongoing or foreseeable expenses – the franchisor must provide details of any payments that you would need to make to them or their associates during the franchise term. This would include costs such as royalties, marketing or advertising fees, uniforms and merchandise.

The franchisor must also disclose payments you make to other people that are reasonably foreseeable by that franchisor or within its knowledge or control, such as staff wages and utilities. Again, upper and lower limits must be provided if a cost cannot easily be worked out.

  • Statement of solvency – the franchisor must provide a signed statement confirming that the franchisor will be able to pay its debts. This statement must generally be supported by either financial reports for the last two years or an independent auditor’s report. If a new statement or report becomes available before the franchise agreement is signed, the franchisor must provide you with copies of them.
  • Previous insolvency – the franchisor must disclose if the franchisor, its directors or associates have been bankrupt or insolvent under administration in the last 10 years. If the franchisor was insolvent during the last two financial years, they must disclose when they were insolvent, and provide you with a statutory declaration and auditor’s report about the current solvency of the business. Penalties can apply to franchise systems that fail to supply this information. For example, in 2017, the franchisor of the Pastacup franchise system was ordered to pay penalties of $100,000 because its disclosure document failed to disclose that its cofounder and former director had previously been the director of two Pastacup franchisor companies that became insolvent.
  • Supply arrangements and restrictions – the disclosure document must include any limitations on the suppliers from where you buy goods and services, or whether the franchisor has nominated specific suppliers you must use. If there are any restrictions on sourcing supplies or services this may need to be factored into the cost of the business.

Tip: If you become a franchisee, you can request a copy of the franchisor’s latest disclosure document once every 12 months.

Significant capital expenditure

As a franchisee, sometimes you might be asked to spend money on things that you didn’t expect such as new equipment or stock, or upgrading your store. Under the Code, the franchisor can’t force you to make significant capital purchases unless you agree to it, or if:

  • it was in the disclosure document you were given before your entered (or renewed) your agreement;
  • the expenditure is system-wide and a majority of franchisees agreed to it;
  • it is needed to meet a legal requirement; or
  •  the franchisor justifies in writing why it’s necessary (including the benefits and risks), and how much it’s likely to cost you.

You should always check your franchise agreement and disclosure document carefully before entering a franchise to identify any costs you might face. It’s also a good idea to ask your franchisor whether there are likely to be any future initiatives (such as rebranding or upgrades) that could lead to additional costs.

Earnings information

As part of your dealings with the franchisor or their representatives, they may make claims to you about how much you can earn, how much other franchisees earn or if it’s an existing franchise store, how much the previous franchisee earnt in the past. If the franchisor makes such claims to you, ask them to confirm it in writing. You should also get professional advice to check how feasible these claims are for you.

Get independent professional advice

A crucial step in undertaking your due diligence involves seeking independent professional advice from a lawyer, accountant and business advisor. These advisers will help you to thoroughly review all documentation provided to you. In particular, this advice will guide you with:

  • understanding any guarantees you may be asked to provide;
  • considering any additional leasing or licensing agreements you may be required to enter in to;
  • reviewing the costs associated with the franchise; and
  • developing and testing a business plan, including projected income and expenses.

Speak to other franchisees

When it comes to buying a franchise, the most valuable advice you receive will likely come from the people who were in your shoes. Speaking to current and former franchisees about their experiences will allow you to test what the franchisor has told you. Ask them some questions such as:

  • what have your experiences been like with the franchisor?
  • what sorts of challenges have you experienced with running your business?
  • are you happy with the earnings?
  • would you buy this franchise again?
  • (if they’re a former franchisee) why did you leave the system?

Buying a franchise is a significant financial and personal commitment. For further information about franchising, or for a copy of ACCC’s Franchise manual, visit www.accc.gov.au/business/franchising. To be kept up to date with latest franchise development, subscribe to the ACCC Franchising information network at https://www.accc.gov.au/media/subscriptions/franchising-information-network.

Dr Michael Schaper is the ACCC Deputy Chair. His special focus is on small business, franchising, industry associations and business liaison with the national competition and consumer protection regulator.

A previous president of the Small Enterprise Association of Australia & New Zealand, he has also served as Small Business Commissioner for the ACT, chairperson of the ACT Small & Micro- Business Advisory Council and a director of the International Council for Small Business.

www.accc.gov.au/business/franchising

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.