Getting Into Franchising? Things To Watch Out For
Getting Into Franchising? Things To Watch Out For
Franchising can provide you with the opportunity to operate your own business, while enjoying the benefits of an already established product or service with brand-name recognition.
But success is never guaranteed. It is important to understand the potential risks of franchising and work out if a particular opportunity is the right one for you. So, before you decide to pursue a franchise opportunity, it’s important to:
- Be aware that the financial rewards may not be as high as you would like, particularly in the first few years of the franchise. Make sure the franchisor can provide the level and support that you need.
- Be aware that circumstances can change – the franchisor may change ownership, strategic direction, or even become insolvent.
- Know the factors relevant to the franchisor extending your franchise agreement at the end of the fixed period, and
- Make sure you research the market to understand the level of consumer demand for your product or service and the degree of competition you will face from competitors.
Code Of Conduct
Before committing to a franchise, you should familiarise yourself with the Franchising Code of Conduct. The Franchising Code is mandatory across Australia and regulates the conduct of franchising participants towards one another. The Franchising Code requires the franchisor to provide you with certain information about the franchise. This information will help you make a more informed decision about the franchise opportunity.
The ACCC regulates the Franchising Code and investigates alleged breaches in accordance with the ACCC’s Compliance and Enforcement Policy (available at: www. accc.gov.au/publications /compliance-andenforcement- policy). Franchising Code issues involving large or national franchisors are a current priority of the ACCC.
Under the Franchising Code, franchisors are required to provide prospective franchisees with a disclosure document, a copy of the franchise agreement in its final form, and a copy of the Franchising Code at least 14 days before entering into the agreement or making any non-refundable payments.
The disclosure document contains valuable information about the franchisor, and the franchise system. When reviewing the disclosure document you should:
Check the franchisor’s financial details and confirm that it is solvent. The franchisor must provide a signed statement confirming that the franchisor will be able to pay its debts, and provide either financial reports for the last two years or an independent auditors report.
- Consider the relevant business experience of the people running the franchise system.
- Check whether the franchisor, any of its associates (or a director of the franchisor or associate of the franchisor) has been bankrupt or insolvent in the last 10 years.
- Consider the range of costs associated with establishing the franchisee (such as legal fees, and any initial franchise fees).
- Consider any ongoing and foreseeable payments that you will need to make to the franchisor during the franchise term such as royalties, marketing or advertising fees.
- Check the number of past franchisees. A high turnover rate could indicate problems with the business or other issues.
- Check if the franchise is for an exclusive territory. If your territory is not exclusive, your franchisor or another franchisee could set up shop in the same territory.
- Review the franchisor’s supply arrangements, bearing in mind that restrictions on who you can source goods or services from may affect your bottom line.
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 refurbishing your store. Under the Franchising Code, the franchisor can’t require you to undertake significant capital expenditure during the term of your franchise agreement.
However, a franchisor can require you to incur expenditure if one of following happens:
- You agree to it.
- It was disclosed in your disclosure document (prior to you entering into, renewing or extending the franchise agreement).
- The expenditure will apply to all or a majority of the franchisees in the system, and was agreed to by a majority of those franchisees.
- The expenditure is required to comply with a legal obligation.
- The franchisor considers the expenditure is necessary as a capital investment, and justifies its decision in writing to you including certain matters such as the rationale and amount required.
Always check your franchise agreement and disclosure document carefully before entering a franchise to identify any potential costs you might face. Also, ask your franchisor if there are likely to be any future initiatives (such as rebranding or upgrades) that could lead to additional costs for you as these may affect your decision to proceed with the franchise.
Speak to other franchisees
Some of the most valuable advice you can receive about the franchise will be from the people who have already been in the franchise. The disclosure document should contain the contact details of current and former franchisees. You should speak to as many of these franchisees as you can to understand their relationship and experience with the franchisor.
Questions you could ask include:
- Did they make the amount of money they expected?
- Whether there were any hidden or unexpected costs?
- Have they recovered their investment?
- What level of training and marketing support does the franchisor provide?
- If they knew then what they know now, would they have still purchased the franchise?
- If they exited the franchise system, why did they leave?
Asking these questions of the existing and any former franchisees will provide you with information that you may not get from the franchisor.
Franchisors are not required to provide you with earnings information but some choose to do so. Earnings information could take the form of historical data from other franchisees or projections from the franchisor about how much you could expect to earn. If the franchisor makes claims about projected earnings, ask for the basis of these and get them to confirm it in writing.
Seek professional independent advice
A crucial step before committing to a franchise is that you seek independent legal, accounting and business advice from professionals with expertise in franchising. This will allow you to get an understanding of your legal obligations and any risks affecting the franchise relationship. Check with your lawyer if any clauses of the franchise agreement raise concerns.
Also talk to an accountant about the business opportunity and whether any earnings figures the franchisor has provided are realistic, whether you are likely to recoup your investment (with a reasonable return) within the life of the franchise agreement, and if you can afford the risk of the franchise failing.
If you have entered into a new franchise agreement, you have ‘cooling-off rights’. Under the Franchising Code, a new franchise agreement can be terminated within seven days of:
- Entering into the agreement (or an agreement to enter into the agreement), or
- Making any payment under the agreement. If you terminate during the cooling-off period, you’re entitled to a refund of all your payments within 14 days, less any reasonable expenses incurred by the franchisor (these must be set out in the franchise agreement).
The ACCC has a range of educational resources dedicated to educating small business about their rights and responsibilities under the Competition and Consumer Act.
To keep up to date with the latest Franchising Code developments, subscribe to the ACCC’s Franchising Information Network at: