Overseas/Foreign Franchisors & the new Australian Franchising Code 2015
KEY CHANGES FOR OVERSEAS FRANCHISORS
The key change is removing the requirement for an overseas/foreign franchisor to provide to a sub-franchisee disclosure documentation in addition to the disclosure that is required to be given by the master franchisee to a sub franchisee.
This has reduced unnecessary red-tape, costs and delays in rolling out franchise units for overseas franchisors.
The new Code has also altered the terminology of ‘Master Franchisor’ & ‘Unit Franchisees’.
• A Master Franchisor is an overseas franchisor or Australian franchisor granting rights to a Sub Franchisor (Master Franchisee) or Sub Franchisee (Unit Franchisee).
• A Sub Franchisor (previously Master Franchisee) now issues rights to Sub Franchisees.
The disclosure document has substantially changed and now needs to be updated in the prescribed form under the Code from the 1st January 2015.
Overseas franchisors also need to be aware of the civil penalty provisions that can be imposed by the ACCC for breaches of the Code.
Disclosure Requirements and the Franchise Agreement
Clause 7 – Master Franchisors no longer need to provide separate disclosure to sub-franchisees.
Clause 12 – A Master Franchiso r does not need to comply with the requirement for disclosure to sub-franchisees of information that the subfranchisor (master franchisee) must disclose.
• A Master Franchisor is still required to fully comply with the Franchising Code and provide disclosure to its sub-franchisor, but the double disclosure / joint disclosure to the subfranchisees has been removed.
• There is no need for an overseas Master Franchisor who appoints a sub-franchisor to now provide a separate Disclosure Document in addition to the Disclosure Document provided by their sub-franchisor to subfranchisees.
Item 7 – Master Franchises
If a franchisor is also a sub-franchisor it must give the following details in relation to its master (overseas) franchisor:
• name and address;
• name, position held and qualification of its officers;
• number of franchise agreements terminated, or not renewed; and
• details of the master franchise agreement.
Financial Statements to be Provided by an Overseas Master Franchisor
Master franchisors (Australian franchisors and overseas franchisors) must now attach to their disclosure documents the following financial information:
• A statement signed by the Director as to solvency of the Company at the end of the last financial year attaching the last two years financial statements; or
• An Auditor’s report, supporting the Directors solvency statement.
There are additional obligations of disclosure on master franchisors in relation to:
• End of term arrangements;
• Disclosing information relating to rebates, and incentives from suppliers;
• Disclosing the impact of online sales on individual franchisees.
MASTER FRANCHISE OR AREA DEVELOPMENT ARRANGEMENTS
Master franchising has been the most popular model to enter the market by overseas franchisors. There has been, however, an increase in area development and joint venture arrangements.
An area development agreement is similar to a contract with provision of services usually for a fixed term. The area developer is engaged to develop, recruit, train and support subfranchisees. The franchisees enter into the franchise agreement directly with the overseas master franchisor. The area developer is paid a fee for their services which may be a percentage of the upfront fees and ongoing royalties paid by sub-franchisees.
An area development agreement is not a franchise arrangement under the Code. No disclosure documents are required to be given by an overseas franchisor to an area developer. The termination provisions are therefore not restricted by the Code.
Master franchise rights are granted to operate in a territory or area and to establish franchise units and appoint sub-franchisees. The master franchisor (overseas franchisor) must still provide a Franchising Code compliant disclosure document and franchise agreement to its master franchisee. The master franchisee appointed usually pays a fixed fee or a percentage of the royalties it receives from sub-franchisees to the master franchisor.
Master franchisees need to have significant capital resources not only to acquire the rights, but also to develop the territory.
The master franchisee becomes responsible for recruitment, training and support of subfranchisees. The sub-franchisees enter into a franchise agreement with the master franchisee. Master franchisees take on considerable risk and responsibility and returns on their investment can take some years.
THE RISKS OF ENTERING A NEW MARKET
From our thirty years of experience in the franchise industry we have seen many overseas franchisors enter the market, some more successfully than others.
Many succeed but some do not. The reasons for this in our experience are as follows:
• Overseas franchisors do not conduct sufficient market or demographic research.
• A franchise that might be successful in one state in Australia may not translate successfully to another. There are considerable differences in demographics and market consumer demand between, for example, Queensland and Victoria.
It is important overseas franchisors understand the market and select the correct state in which to enter the Australian market.
• Failing to prepare a proper development plan with local expertise.
• Unrealistic expectations placed on master franchisees. For example, where an overseas franchisor asks for A$350,000 for the grant of the master franchise rights, a percentage of the royalties and an additional sum for each of the sub-franchise units, it will be difficult to attract a master franchisee who carries all the legal risk and responsibility to roll out subfranchises.
• We are now seeing a trend where overseas franchisors are reducing the upfront licensing fees and offering terms that allow payment from each sub-franchise sale. This means a master franchisee can fund the costs over time and retain their working capital to support and propose the brand and attract new sub franchisees.
• We have renegotiated a number of master franchise agreements where unrealistic KPIs were set for master franchisees. Setting a commitment to establish 10 - 12 franchise units in the first 12 months to 2 years is unrealistic. Establishing 2 to 3 sub-franchisees in the first year and then increasing that gradually over time will be more achievable and avoid disappointment. Setting unrealistic KPI’s on master franchisees place them under unrealistic pressure.
• Locally appointed master franchisees now expect overseas franchisors to provide sophisticated online and real time accounting and support systems.
• Franchisees now expect a greater sharing of risk. Overseas franchisors now more than ever need to share the risk with local franchisors and take a longer term view by lowering the entry costs to make it more affordable for subfranchisees.
• Despite Australia’s relatively strong economy and low interest rates it is still a tight financial market and franchisors need sufficient working capital to fund the roll out costs.
In summary, overseas franchisors should:
• Engage local franchise specialists, lawyers, accountants and consultants who are members of the Franchise Council of Australia (FCA) – the Australian nationally recognised industry council.
• Conduct market and feasibility research and prepare a development plan before entering the market.
• Engage local consultants who know the demographics and local market trends.
• Set realistic fees for the grant of the rights.
• Set realistic expectations in relation to KPIs for roll out of units by the master franchisee.
• Be prepared to invest considerable sums of money before seeing a return on investment. As with any business opportunity, a return on the capital invested may not be achieved for some 2 – 3 years.
Robert Toth is a recognised leader in franchising law in Australia and a published author on franchising law and establishing business operations in Australia with over thirty years of experience in the industry. Marsh & Maher franchise lawyers have a network of franchise consultants ready to assist overseas clients to ensure their legal compliance with the new Code and currently act for a number of overseas companies and foreign franchisors that have successfully established their business operations in Australia.
Contact Robert at:
T: 03 9604 9400