Things To Consider When Buying A Franchise
Franchising is a popular choice for Australians wanting to move from employment to owing their own small business. Buying into an established business system with a known brand is generally less risky than developing a business from scratch.
Note however, a franchise system is designed to assist the operator by giving them instructions on what to do (like an operating manual). If someone is not interested in being told how to run ‘their’ business, a franchise is definitely not for them!
When considering buying into a franchise, we recommend you consider the following before you sign any agreements.
Use the services of professional advisors
You should enlist the services of both Business Advisors/Accountants and Solicitors, experienced with franchise businesses, during the process of purchasing a franchise.
These advisors can help you with the following and more;
- Establish family business structure
- Cashflow forecasts
- Assess value of existing business vs asking price
- Due diligence review
- Review of offer & acceptance
- Review of franchise agreement
- Review of lease agreement
It would also be prudent to speak with a finance broker to determine the maximum safe level of funding you could access, to purchase a business.
What type of franchise site are you buying?
Franchise businesses can be purchased as either;
- Existing (i.e. currently operated by a franchisee or a franchisor)
- Greenfield (i.e. a new location without any trading history)
An existing store is easier to assess in terms of profitability, as actual sales data is available (like any existing business). If the store is performing well, it is likely to be sold at a higher price, whereas if the store is performing poorly, the price should be lower, although this is not always the case.
On the other hand, it is difficult to assess the potential profitability of a greenfield site. No sales history means additional care should be taken in assessing the location, demographic and all other aspects to see if the new site will be a success. If a greenfield franchise works out, the franchisee can generate their own goodwill, by turning it into a profitable business.
Conduct your own Due Diligence
All prospective franchisees should do their own due diligence first. The more they do before incurring advisor’s fees, the better. This will also allow them to ascertain how invested they are in the idea of operating their own business.
This should include research on at least;
- What type of franchise system and royalties payable
- Profitability or expected income
- Brand’s reputation within the market
- Any recent bad publicity
- Franchisor’s expansion plans
- Relationship between franchisor & franchisees (talk to franchisees directly)
- Total cost to purchase and be ready to start trade
- Level of assistance provided by franchisor
- Exit costs when selling onto another franchisee in the future
Is the location viable?
This is applicable for all franchises, more so for greenfield sites.
Items that should be examined;
- Is it attractive and accessible to potential customers?
- Is there an appetite for your product/service offering by locals?
- Is there enough population in your territory to allow for a profitable business?
- Where are your competitors now and foreseeable future?
- Is there a territory or protected area, prohibiting another store to be setup?
- If your store includes a drive-through, has traffic flow been considered?
- Is there enough parking?
Key Documents for Review
The Franchising Code of Conduct (the Code) regulates Australian franchises and is administered by the Australian Competition and Consumer Commission (ACCC).
The Code requires the franchisor to provide various documents at least 14 days before the franchise agreement is signed or before they accept a non-refundable deposit. These include;
- Disclosure document in the form prescribed by the Code
- Copy of the Code
- Franchise agreement in the form you will need to sign it
Potential Additional Documents
There may also be the following additional documents depending on circumstances;
- Confidentiality agreement (will usually need to sign before receiving any information about the franchise system)
- Sub-lease agreement, if your business will be run from a site leased by the franchisor
- Lease agreement, if you are directly responsible for the location
- Contract of sale of business, if you are buying the franchise from another franchisee
As mentioned above, the franchise agreement is one of the documents you’ll need to review/sign as part of entering a franchise system. This in our opinion is the most important!
The franchise agreement establishes the legal relationship between you and your franchisor for the duration of the franchise term. This is generally a long-term non-negotiable agreement and it is difficult to withdraw from, once you‘ve signed it. Unfortunately, ignorance is not a defence when it comes to issues after signing a franchise agreement.
Although franchisors are unlikely to change their agreements to fit the needs of franchisees, they do make slight variations when requested by the franchisee’s solicitor. It is therefore imperative that any prospective franchisee gets appropriate advice before signing.
The franchise agreement covers the following, which is not an exhaustive list;
- Franchisor’s obligations
- Franchisee’s obligations
- Territory area and various restrictions
- Duration of the franchise term and any renewals
- Upfront costs
- Ongoing royalties and advertising contributions
- Costs involved with transferring site to a new franchisee
- Minimum performance requirements
- Outline of where either party could terminate the agreement
- Restraints of trade following franchisee leaving the system
- Outline of steps involved when trying to sell your franchise to someone else
How satisfied are fellow franchisees?
Your franchisor’s disclosure document must include contact details for current and some past franchisees. We recommend you talk to as many as you can, to hear what they have to say about the brand you are looking to buy into.
Ask them the following;
- How actual setup costs compared to original estimates
- Whether profits they are generating are as high as they had expected
- Level of support offered by the franchisor
- Value for money regarding national advertising levies
- Strength of the relationship between franchisee and franchisor
- For those no longer with the brand, ask why they left
What costs are involved?
The actual funds required to purchase any business don’t just end at the list price. So if you don’t budget for all applicable costs, you may find you are not able to afford the purchase after all. This will only put you under financial pressure in the future, which may lead to your business going under.
Consider the following costs;
- Initial purchase (goodwill to existing owner)
- Initial franchise fee
- Franchisor’s legal & administration fees
- Training costs & travel/accommodation
- Advisor’s fees
- Lease guarantees
- Starting capital
- Till float
- Existing site refit costs
- State transfer duty/stamp duty (existing stores only)
Are you considering buying a franchise? Contact us today to speak to our highly skilled advisors.