Buying a Franchised Business

201501.15

Franchising is a business model whereby the franchisor grants to the franchisee the right to operate a business utilising a trade name and business system.  The franchisor usually exercises a high degree of control over the franchisee through established management, marketing and operating procedures.

Franchising has been successful as it usually provides a tried and tested business model, brand recognition, and the benefits of national advertising and promotion.  In many cases, banks are also more likely to provide funding than for non-franchised businesses.  There is also a relatively low failure rate amongst well established franchises.

In most instances, franchisors directly or indirectly collect payments from franchisees for the right to use their brand and to participate in their system.  Franchise fees can range in price (for up-front franchise fees and set-up) from as little as $5,000 to as much as $1 million, or more. Typically, franchisees are also required to pay ongoing fees (or royalties) for franchise support, which may be a fixed monthly amount, or calculated as a percentage of turnover.

Franchising Code of Conduct

The purchase of a franchised business is different to the purchase of a non-franchised business due to the operation of the franchise agreement and the Franchising Code of Conduct (Code).  This is a mandatory industry code that has the force of law under the Competition and Consumer Act 2010 (the Act).  The new Code came into effect on 1 January 2015.

Under the Code, franchisees are provided with various protections in relation to disclosure, terms that must be included in the franchise agreement (as well as prohibited terms), cooling off rights, ‘good faith’ obligations, and dispute resolution procedures. The franchise agreement and the Code will determine how the transaction is conducted and, in fact, whether it can proceed at all.

As a prospective franchisee you are entitled to receive an information statement, a copy of the Code, a disclosure document and a copy of the franchise agreement in the form in which it is to be executed not less than 14 days before entering into the franchise agreement (this also applies if you are looking to renew or extend the franchise agreement).

Disclosure Document

The disclosure document must be prepared in the required form by the franchisor.  This will give a prospective franchisee important information which includes:-

  • details of the franchisor’s business experience and litigation history
  • payments to be made by the franchisee to the franchisor
  • details of existing and past franchisees
  • details of the supply of goods and services
  • details of marketing or other cooperative funds
  • details of the franchise site or territory
  • prepayments and establishment costs
  • arrangements for the supply of goods or services
  • copies of any leases, sub-leases or other documents relating to the franchise.

Before you commit to purchasing that new McDonalds down the road, you should consider the following:-

  • did you get a copy of the Code and the disclosure document? Have you carefully reviewed and understood the contents of the documents?
  • has the franchisor been in business for a reasonable period of time? Find out as much as you can about the franchising system by speaking with other franchisees.
  • ensure you have adequate borrowing capacity, including working capital, to successfully establish this type of business.
  • how much are the weekly/monthly royalties? Are they a percentage of purchases or gross revenue? A higher fee does not necessarily represent a better offering.
  • how long is the franchise term for? and can it be renewed?
  • is the landlord requiring you to enter into a lease or a licence agreement for the premises? Does it matter?
  • has the franchisor’s brand been established, trademarked and protected?
  • what administrative and management support will the franchisor provide?
  • is there wide public awareness and acceptance of the product or service? You should avoid businesses in declining markets and “fads”.
  • is there a detailed Operations Manual and on-line support for you as a franchisee?
  • will you receive a Territory and will it be exclusive?

Role of your Lawyer

A lawyer who is experienced in franchising can assist a prospective franchisee in a number of ways.  Whilst it is not necessary for a lawyer to review every document provided by the franchisor, it will be necessary to review the franchise agreement and disclosure document.

The important aspects that a lawyer can advise on include:

  • whether or not the franchise agreement and disclosure document contain all information which is required under the Code
  • whether any payments under the franchise agreement are inconspicuously located in the body of the franchise agreement rather than the schedule.
  • if there is an option to renew, whether or not there are any conditions for renewal which may include a renewal fee, or refurbishment of the premises.
  • whether the term and further term of the franchise agreement coincide with the lease and/or licence agreement.
  • the conditions which may be imposed on a subsequent sale or assignment of the business
  • the grounds upon which the franchise agreement can be terminated
  • whether any proposed restraints of trade are reasonable

Whilst it is true that franchisors are generally reluctant to amend their franchise agreements (particularly in well-established systems), a good lawyer will be able to identify important or unusual clauses and negotiate their deletion or amendment on your behalf.

Franchisees should also be aware that they may terminate a franchise agreement within 7 days after entering into the agreement as part of the cooling-off provisions.  If a franchisee exercises such rights, they should get a refund for any monies paid less reasonable expenses.

The decision to own and operate a business generally represents a major financial and legal decision.  And, yes, franchises do fail! As such, you are encouraged to do your own research, speak with other franchisees in the system, and consult with your accountant, business advisor and lawyer before you commit yourself.

Matthew Baker-Johnson, Principal of Avery Commercial Lawyers

Matthew is an experienced commercial and property lawyer who regularly advises clients in relation to sale of business and franchising transactions.  He is a member of the Law Institute of Victoria (LIV) and an associate member of the Australian Institute of Business Brokers (AIBB).

Disclaimer:

The information contained in this article is intended to provide general information only and is not legal advice or a substitute for it. You should always consult your own legal advisors to discuss your particular circumstances.