Once you’ve selected a franchise, the next step is to analyse it thoroughly to determine whether it is really worth buying. During pre-contractural negotiations with franchisors, prospective franchisees should seek the following:
A draft franchise agreement
Professional legal and accounting advice with regard to terms of the franchise agreement
A copy of the Franchising Code of Conduct
A signed current disclosure document as set out in the relevant Annexure to the Code.
A requirement under the Franchising Code of Conduct is the provision by franchisors of a formal Disclosure Document.
The purpose of a disclosure document is to give a prospective franchisee current information that is material to the running of the franchised business so that they can make a reasonably informed decision.
The Code states that a franchisor must before entering into a franchise agreement and within three months after the end of each financial year after entering into a franchise agreement, create a disclosure document for the franchise.
The Disclosure Document
The disclosure document should include the following information:
The name and registered office of the franchisor, and whether they are a member of the Franchise Council of Australia.
The names, job descriptions and qualifications of the directors, executive officers and principals.
A detailed resume of the business experience of the franchisor and its directors, secretary, executive officers and principals.
A viability statement with key financial information about the franchisor.
Details of any relevant debt, legal proceedings, or bankruptcies or insolvency’s concerning the franchisor or any of its directors, executive officers or principals.
A summary of the main particulars and features of the franchise, e.g. logo, history of franchise system, trademarks, payment details, territory restrictions.
A list of the components making up the franchise purchase, such as the franchise fee, stock, fixtures and fittings and working capital, with estimated individual costs detailed to reflect the full outlay. A summary of the items that could be leased and the estimated costs involved should also be included.
Details of any financial requirements by the franchisor of the franchisee, such as a specific amount of non-borrowed capital towards the franchise purchase price.
The number of existing franchises and company outlets. A list of existing franchisees should also be available.
Where written projections are provided about the levels of potential sales, income, gross profit and net profit, details of the basis or assumptions on which the projections are made should be provided.
A clear statement indicating whether or not the projections include depreciation, any salaries or wages for the franchisee and the cost of servicing loans.
A statement as to whether the territory or site to be franchised has been subject to any trading activity, particularly a previous franchise. If so, the history and details, including the circumstances, of any cessation of the franchise.
It is important to remember here that the disclosure document is NOT the franchise agreement, although it contains a summary that refers the reader to certain sections of the franchise agreement.
You and your lawyer need to read everything contained in the franchise agreement itself before you sign it.
Features of the best practice franchise systems
The following is a list of the best practice features of a franchise system. Consider these points when evaluating a particular franchise:
A method for site selection
The exclusive right to operate the franchise in the chosen territory
Training for the franchisee before entering and during the term of the franchise agreement
A democratically elected franchise advisory council including franchise representatives
Internal system for dispute resolution
Operational manuals made available to the prospective franchisee prior to entering into the franchise agreement
Clearly stated terms, rights or renewal, transfer and termination of franchise agreement.
Frequently asked questions
It is important to know what to ask when entering into any kind of contractual arrangement. The following is a list of frequently asked questions that you may find useful.
Is a franchisee expected to pay fees to the franchisor prior to signing the agreement?
Some franchisors request that franchisees pay a deposit of several thousand dollars prior to signing a franchise agreement. However, this requirement varies from system to system.
What documents will a franchisor ask a franchisee to provide?
A franchisor may request that a franchisee prove that their finance has been approved. In addition, a franchisor may ask for evidence of the availability of working capital to operate the franchise.
Will a franchisee be expected to have prepared a business plan at this point?
As franchises are run according to a system, a franchisor may not want a business plan prepared. On the other hand, it may be a requirement when applying for finance through a financial institution. An accountant will be able to help a prospective franchisee do so.
What is a franchise fee payment?
A franchisee fee is generally a one-off payment made by the franchisee in consideration for the granting of the franchise licence. It is paid when the franchise agreement is executed.
What and how to gather relevant information
Much of the information you’ll need to gather in order to analyse a franchise will be acquired through the following:
Interviews with the franchisor
Interviews with existing franchisees
Examination of the disclosure document and franchise agreement
Franchise Ratings Australia will assess a franchise disclosure document by assessing key risks, benchmarking best practice and identifying potential areas of dispute
Examination of the audited financial statements
An earnings-claim statement or profit and loss statement
Industry and trade-area surveys
Newspaper or magazine articles about the franchise
A list of the current assets and liabilities.
Questions which need to be answered
Through this research, you want to answer the following questions:
Are the franchisor and the current franchisees profitable? If the franchisor is not making a profit and franchisees are merely struggling to survive, the business may not be as viable as you thought. Look at other businesses in the same industry to gauge the prospects for success. Although franchises have a considerably low failure rate, they’re not immune to it.
Is the franchise well organised? You don’t have to know anything specific about a franchise to know whether or not it is well organised. If you go into a franchise outlet and see that they aren’t well organised and don’t seem to know what they’re doing, then that’s not a business worth considering. Most franchisors have developed monitoring systems that allow franchisees to diagnose problems and measure their progress, and help them deal with problems more effectively.
Does it have regional or national adaptability? You want a franchise that will grow regionally or, better still, nationally so that it will increase your business locally.
Does it enjoy a growing public acceptance? While it’s good to have a certain amount of uniqueness, you don’t want to be in a business that’s so radical you’re going to risk your entire life savings on whether or not people are going to accept the idea or concept. Many times, you can feel that you are on the crest of a wave of a new concept, and you can see that it’s taking hold everywhere. But if the concept is not tried and proven, be very cautious.
What is its point of difference or unique selling proposition? You probably won’t have much success if you try to open just another version of many existing businesses. There has to be something different about the franchise. A franchise that has some point of difference over other businesses is a much better investment, because that point will set you off from other people.
How good are the financial controls of the business? You want the franchise to be backed by a franchisor with strong financial management ability so you can determine the financial health of the franchise at both the corporate and unit level.
Is the franchise credible? The franchise should have a good track record. That doesn’t mean it has to have been in business for 10 years, but there should be enough of an operating history to show that it is a viable concept. This includes a good credit rating. If the franchise is in financial trouble, it will show in the credit rating.
What kind of exposure has the franchise managed to attain, and how has the public reacted? Find out if the business has had any write-ups in papers or magazines, and determine what the public’s opinion of it is.
Are the cash requirements reasonable? The investment should be proportionate to the kind of return that you will get as the owner / operator. Realistically, you should be getting a return as an employee of the business (what you would have to pay someone else to do the work you are doing), as well as a profit on your total investment.
Does the franchisor have integrity? Are they committed to your success? This is very important. If the franchisor is willing to take your money without checking you out, that’s a sign of trouble. The more particular a franchisor is, the more confident you can feel that the other people in the system are going to be good people as well.
Does the franchisor have a monitoring system? A monitoring system is a series of consistent control checks for both the franchisee and franchisor. The checks monitor both financial performance and compliance with set procedures and policy. The system should be designed so that it portrays the franchisor as a mentor, providing targets and inspiration for consistency and improvement. This will allow you to know what your challenges are, so you can deal with them more effectively.
Which goods are proprietary (must be purchased from the franchisor)? Keep in mind that the franchisor generates profit through the sale of proprietary stock marked up from the wholesale or manufactured cost. Determine which items are proprietary and must be purchased through the franchisor, and which can be acquired through outside vendors at a reduced cost.
This method of supplying franchises through the franchisor has been the subject of many disgruntled franchisees. If the franchisor is simply acting as a ‘go-between’ so that it can collect its mark-up, then you would have to consider the franchisor’s interests. For example, is he/she more interested in your success or their own? Remain wary of any franchisor requiring supply through itself only. The most valid reasons for the franchisor acting as a ‘go-between’ supplier are:
It is able to command bulk discounts by combining purchases of all franchisees.
It is in a position to enable it to command changes to the product so that it fits in better with your franchised business program.
It is in a position to inspect suppliers’ processes and supplies to ensure a quality product is supplied to your franchise.