So, you think buying a franchise is a good idea?
You’ve reached the end of the year and think it might be a good time to move into self employment. No more “working for the man”! Perhaps a franchise might be a great idea? You have heard that owning a franchise takes away some of the risk you might have if you were purchasing a standalone business. You like the fact that the franchisor will help you get started and provide you with ongoing support. What is there to lose you ask yourself? How can it possibly go wrong?
As franchise lawyers we often come across sad cases of people who were so keen to buy a franchise that they did not get the right advice or undertake a detailed due diligence. The fact that it is a franchise business does not in itself provide any guarantee of success. While some franchises could be more successful than a stand-alone business this is not always the case.
Franchise purchases often involve large sums of money and long-term commitments particularly if a lease is entered into. We have developed ten rules which we believe must be followed by anyone who is seriously contemplating buying a franchise. Following these rules could help ensure that you do not make a hugely expensive mistake:
Rule One – TAKE YOUR TIME – we can’t stress this enough. A common selling technique is to create a sense of panic, that you might miss out on the deal of the century if you don’t act now. This pressure should in itself create a misgiving in the minds of any potential franchisee. It certainly does for a franchise lawyer! You need to give yourself and your advisers the time to conduct their investigations. You need time to make sure that you are as comfortable as you can be with making this big commitment.
Rule Two – GET ADVICE - we often find franchisees come to us after they have signed the agreement and problems have arisen. Unbelievably, we find that quite a few of these clients never received any form of professional advice before they signed along the dotted line. Getting professional advice prior to entering into the franchise documentation is essential on a couple of levels. Firstly, it ensures that you know exactly what you are getting into. Issues like restraints of trade can have a serious impact on your ability to carry on a business after the agreement ends so it is important that you are aware of the potential implications of the clauses in the franchise agreement. Secondly, sometimes we are able to negotiate beneficial changes to agreements such as leases, an example is making sure that any personal guarantees you have given under the lease are released when you sell the business. Without this release you will remain personally liable for the balance of the term of the lease. In short, the value in getting advice from an experienced lawyer and accountant cannot be underestimated.
Rule Three – KNOW ALL THE COSTS – a common issue we find is franchisees being unaware of all of the costs involved. If premises are being fitted out - what are the total costs? Is it a fixed fee? If not, what happens if there is a cost blow out? What about costs for purchasing stock, uniforms, initial equipment and recruitment? There are also usually software licence costs, the franchisor’s legal costs and costs for initial promotion. The franchisor should provide you with a detailed breakdown of all the costs you are likely to face.
Rule Four – CAN YOU DO THIS? - Operating a franchise business is a pretty big commitment and typically in the first few months your life will be consumed with working in the business. Do you understand the total commitment involved? Will this fit in with your other commitments (e.g. family and leisure activities)? Most importantly can you see yourself enjoying operating the franchise business? Obviously having a passion for what you are doing, and a sense of enjoyment will make the hard work a lot easier. We suggest you talk with other franchisees to get a sense of the total commitment.
Rule Five – FIND OUT WHAT IT IS REALLY LIKE – hopefully the franchisor will get a realistic picture of what it will be like being a franchisee. Unfortunately, sometimes in the selling process there can be a tendency to oversell the opportunity. We strongly recommend you sit down with other franchisees and ask them what it is really like to own the franchise business. Ask them questions such as how long did it take to break even? What actual support does the franchisor provide both initially and over the long term?
Rule six – FIND OUT ABOUT THE MARKETING – one of the perceived benefits of owning a franchise is the fact that the marketing fees are pooled into a central fund which is managed by the franchisor, so you get the benefit of scale, something you would not get if it was a standalone business. However, we believe it is essential to understand exactly what sort of marketing the franchisor has done and will be doing? Ask for examples of what marketing has occurred in the past and what marketing plans are there for the future? We also think it is important that there is some transparency and reporting around the marketing fund. Will you get annual statements? Are the funds held in a separate account?
Rule seven – BE COMFORTABLE WITH THE PROFITABLITY - Obviously there are no guarantees and there will usually always be a period of time before you break even. You should work with your accountant to prepare a business plan, so you know all costs involved and how long it could be before you make a profit. Your franchisor may even have business plan templates which you can use. Sometimes the franchisor will provide you with projections. These should not be relied on as an indication of the likely performance of your business. Ask the franchisor to provide you with details of the financial performance of both the most successful and least successful franchisees. This should give a guide on what other stores have achieved even though the success of your business will largely depend on your own efforts. You need to understand there is no guarantee of the likely money you will make from the franchise business.
Rule eight – ESTABLISH THAT THERE IS A DEMAND - With existing systems it is easy to understand what sort of demand there is for the products and services sold as part of the franchise. However, this could be dependent on the location, so you need to check the competition located in your area With new systems it is not that easy to establish the demand for the goods and services. We have certainly experienced situations where franchise systems which have been successful in Australia are not successful here. Do your research and be comfortable that there is a demand for the goods and services which the franchise offers?
Rule nine – CHECK OUT THE FRANCHISOR – part of what you are purchasing is the franchisor’s experience and expertise in running a franchise. Don’t be too scared to ask the franchisor for these details. You know what you bring to the table, so you should find out what the franchisor can bring. Who are the people at the franchisor’s head office who will be supporting you? How will they provide this support? Are there enough staff to help support all of the franchisees? Can they give you an example of the actual support they will provide?
Rule ten – IF IT SEEMS TO GOOD TO BE TRUE IT PROBABLY IS – yes this is an old saying but we have found it applies to franchising also. We don’t know of any franchises which don’t require some element of hard work and dedication. There is also a financial risk associated with every purchase of a franchise. So, we say to you if the franchise opportunity seems too good to be true then it probably is. All the more reason to get the advice and undertake the investigations required to ensure you are comfortable with the investment you are about to make.
We believe that following these rules is mandatory for every person who is looking at purchasing a franchise. Like any business there are some outstanding franchises out there but there are also some very average ones. Dig a little deeper, get advice and take your time. The lawyers at Turner Hopkins are here to help you make the best decision.
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“Joy, we cannot thank you enough for your help with our purchase! You have been wonderful to deal with and so proactive (and patient with my numerous emails). We will be visiting NZ in April so will make sure we drop in to thank you in person.”