Services

HG Alert: Franchising: Recipe for Success? - Feb 2009

Franchising continues to be an extremely popular business model in a range of different industries in Australia. The Franchise Council of Australia estimates that there are over 1000 franchise systems and over 70 000 franchise units in Australia. Many prospective first-time business owners look to franchising as a way to enter the market, often viewing franchised businesses as a ‘safer’ means of entry than stand-alone operations. Well operated franchise systems can, and do, provide a level of training and support to franchisees that may not be present in other business models. However, in franchising (as in any business) there is no guarantee of success, and there are a number of matters that any prospective franchisee should consider before buying a franchise.

If you’re thinking about becoming a franchisee, here are some initial legal considerations to help you in your research and decision making.

Understanding the Franchisee’s Role

A common misconception about franchised businesses is that they can be acquired as a ‘passive’ investment. Some prospective franchisees believe that the existence of a franchise system means that the business will effectively run itself.

That is rarely the case – even the most sophisticated franchise operations require a degree of involvement from the business owner and competent managers. In evaluating whether to buy a business, you, as the prospective franchisee should make sure you understand how much personal involvement will be required.

This will depend on a range of factors, including the nature of the business and whether functions such as marketing are centralised by the franchisor. Some franchise systems operate heavily centralised marketing campaigns, whilst others leave the marketing of individual stores largely in the hands of their franchisees.

Understanding the Franchisee’s Obligations

Having a comprehensive understanding of the franchise agreement is central to understanding your role as a franchisee and your obligations under the franchise system.

Detailed legal and financial advice on the franchise documents is critical in this process. Franchise agreements are generally lengthy documents which set out, in detail, the franchisee’s obligations regarding issues such as marketing, training, redecoration, rebranding and payment of franchise fees and other royalties.

Most franchise systems will also have a manual which sets out other operational and procedural requirements which must be complied with by the franchisee. Again, a detailed review of this document is critical in understanding your obligations as a franchisee.

Understanding the Franchise System

The nature of a franchise system will also impact your obligations as a franchisee.

Some franchise systems, for example, require franchisees to acquire all (or at least a majority) of products through a centralised wholesaler, which may be an entity related to the franchisor. In these types of systems, the trading terms need to be considered in conjunction with the franchise fees and royalties that are payable. Other franchise systems allow franchisees to buy products from a range of different suppliers (or any supplier) as long as the products meet certain criteria. Even so, franchisors are often entitled to rebates from suppliers for products sold to franchisees and these should also be considered in the context of franchise fees.

Your obligations to landlords regarding the premises where the franchised business is located must also be carefully considered, particularly where the franchisor is the owner or holds a head lease over the property.

Disclosure

Franchisors are required to provide you, as a prospective franchisee with a disclosure document, which sets out critical information regarding a range of matters related to the franchise system.

The disclosure document must include, amongst other things:

  • details of any requirements to purchase products from particular suppliers and any rebates which the franchisor may be entitled to receive; and
  • contact details for current and past franchisees and details of any disputes to which the franchisor has been a party.

This information can provide a useful insight into the franchise system and the level of satisfaction of existing and past franchisees with the system and their businesses generally. Financial information disclosed by the franchisor also requires careful analysis and advice.

The research and due diligence process that you, as a prospective franchisee should undertake when evaluating a franchise is really no different to that undertaken in relation to any business. However, one of the key advantages when buying a franchise is that most of the information needed to evaluate the business is in the disclosure document and franchise agreement. Legal and financial advice is, nevertheless, critical in unlocking the information in these documents and ensuring that you understand your role, your obligations and the franchised system so that as the prospective franchisee, you are fully aware of the risks associated with the franchise before investing in it.