A TASTE FOR FRANCHISING POST-COVID
Food and beverage franchises are bouncing back in the wake of COVID-19. Many in the heart of our cities took a hit during the pandemic with a large part of the Australian population working from home. Franchisees were forced to pivot by starting home deliveries and quick take away services.
By and large food and beverage franchises have weathered the COVID storm. Unable to travel overseas, people have more disposable income to spend at home. They’re more likely to indulge in a novelty dessert, go out for coffee or take their families to a fast-food restaurant.
During COVID the Australian Competition and Consumer Commission (ACCC) advised franchisors to adjust their fees so that franchisees were not paying for services that they were not receiving. Franchisors were also asked to consider suspending services, such as marketing, so those savings could be passed on to franchisees. However, there were no legislative requirements for franchisors to waive, reduce or defer franchise fees during the pandemic.
Now on the road to recovery, there’s a growing appetite for some franchisees to add to their portfolio as business confidence is re-built. One of our franchisee clients, who is a multi-unit franchisee, is looking to acquire more locations, while for workers who lost their jobs during COVID the lure of being the master of their own destiny can be appealing.
The challenge of starting a new business is daunting when it’s a new idea and the brand is unknown. Going out on your own can carry a high level of risk whereas many see taking on a franchise as a more calculated measure. There’s the security of a proven concept, a level of certainty and a trusted brand people already know. There’s also the support of the franchisor, the marketing and business teams and regular visits from the area manager.
Unfortunately, many in the market for a franchise don’t know their rights and responsibilities and this can lead to legal disputes. Equally, franchisors can run into trouble if they lack experience with franchising and if franchise agreements don’t clearly state expectations and requirements. The good news is many problems can be avoided if both parties have their eyes wide open when signing on the dotted line.
In our experience, here are some of the traps to avoid.
Traps for franchisees
- Not doing your homework on the brand, sales, location of the franchise and customer profile.
- Not understanding that franchising is essentially a licence to use the brand and operate the business for a limited period of time. Ensure your financial modelling reflects that.
- Not reviewing financial statements through a franchise lens, especially if you are buying a business previously operated by a franchisor. For example, do the financial statements reflect the royalty payable to the franchisor?
- Fit-out costs for a new site blowing out.
- Expecting to have more flexibility with the menu, products and suppliers than the franchise model allows.
- Lease obligations (including the requirement to provide personal and bank guarantees), increasing rent and refurbishment costs.
- Unexpected costs imposed by the franchisor to keep up with upgrades to the brand.
Traps for franchisors
- Not being aware of obligations under the Franchising Code of Conduct. There are significant financial penalties for breaching some provisions of the Code.
- Not encouraging franchisees to obtain legal advice before they sign a franchise agreement.
- Incorrect representations being made to a franchisee during negotiations about the business. This could lead to a claim by the franchisee down the track.
- Time (and legal costs) spent dealing with franchisees who are in breach or don’t follow the model. For example, franchisees may make late payments, sell unapproved products, source products from unapproved suppliers or change the branding.
- Dealing with franchisees that resist implementing required changes.
Anyone considering entering into a franchise arrangement should be aware of the following:
Before you sign on the dotted line
- A franchisor must comply with the requirements of the Franchising Code of Conduct.
- A disclosure document must be provided to a franchisee 14 days before the franchisee signs a franchise agreement. That time should be used by a franchisee to complete due diligence and seek advice.
- A franchisee has a 14-day cooling off period after signing the franchise agreement to decide whether to proceed. By that stage, however, a franchisee may have probably signed a lease or completed on the business acquisition from the franchisor or another franchisee, so it may be difficult to walk away.
- Franchise agreements can be lengthy and include matters such as payment of fees and royalties, the length of the term and whether there are any options for renewal, the use of the intellectual property, arrangements about the premises, marketing methods, approved products and suppliers, restrictions on the sale of the business, end of term arrangements including restraint of trade clauses and how the agreement may be terminated.
- A franchise agreement is usually supported by an operations manual which can be updated by a franchisor from time to time to change or modify approved products, suppliers, plant and equipment, the brand image etc. A franchisee should seek a copy of the operations manual when considering the franchise offering as a whole.
- A franchisee should seek feedback from other franchisees before signing up. Contact details of current and former franchisees appear in the disclosure document for this purpose.
Ending the relationship
- Most franchise agreements are for a specific term with no early termination right for a franchisee. That means a franchisee cannot walk away from the franchise agreement in the middle of the term without negotiating an exit arrangement with the franchisor or selling the business to an approved purchaser.
- If a franchisee breaches the franchise agreement or walks away early, a franchisor may have a claim against the franchisee (and any guarantors) for loss of royalties, lease payments, legal costs and other expenses.
- At the expiry of the franchise agreement, the franchisor may offer to purchase the franchisee’s plant and equipment pursuant to the arrangement set out in the franchise agreement.
- There may be a restraint of trade provision that will prevent you from competing with the business or operating from the site under a different brand.
Food for thought
Many food and beverage franchisees don’t seek legal advice because they assume terms and conditions of a franchise agreement are non-negotiable. Although it is often a franchisor’s position not to negotiate the basic terms of the franchise agreement, there is often room to tailor or at least clarify provisions that may have significant consequences for a franchisee. For example, a franchisee may request that a franchisor not require a major upgrade of the store for five years. That way the franchisee isn’t having to fork out for big ticket items like new equipment, store refurbishment or rebranding while they’re trying to build up the business. Legal advice should be sought to ensure there are no surprises down the track.
Seva Surmei is a principal in the transactions team of DMAW Lawyers which is a leading South Australian based commercial law firm providing services throughout Australia.
Seva specialises in franchising, licensing and distribution, in particular, acting for major franchisors in the establishment, development and operation of franchise systems including providing advice in respect of compliance with the Franchising Code of Conduct.
Seva is a committee member and secretary of the Franchise Council of Australia, a committee member of the Women in Franchising group and has recently been named as a leading lawyer in franchise law by Best Lawyers (2021 and 2022 editions) and franchise lawyer of the year Adelaide (Best Lawyers 2022 edition).