Got your eyes on a new franchise opportunity? It’s not as easy as just signing on the dotted line. Like any financial investment, you need to do your homework, and in the franchise sector, that means performing a detailed and accurate due diligence process.
“Starting a business is not risk free, and this applies equally to a franchise as it does to any other form of business,” Australian Competition and Consumer Commission (ACCC) deputy chair Mick Keogh says. “Even where the franchisor and franchisee comply with the law, starting a new franchise business carries risk. When you are proposing to invest your own time, money and passion in a business, you need to take steps to reduce risk.”
Step 1: Read and understand the disclosure document and franchise agreement
A disclosure document is designed to explain important information about the franchise before you enter into the agreement. The information must be given to you regardless of whether it encourages or discourages you to buy. “The franchise agreement is the legally binding contract between you and the franchisor. You should take the opportunity to negotiate changes to it if you need to,” Keogh says.
Both documents must be provided to you before you sign or pay non-refundable money to the franchisor. Keogh reiterates the importance of not only reading through the documents, but understanding them thoroughly.
“It is critical that you read and understand both the disclosure document and the franchise agreement, and any other key documents such as a lease, licence agreement, or a purchase of business contract,” he says. “You should expect that there will be parts that are difficult to understand. Be prepared to ask questions. Begin by asking questions of the franchisor and make notes of what they say. Remember, if they tell you something that makes you more likely to buy the franchise, get them to put it in writing.”
It is not unusual to receive nearly 100 pages of information, including the franchise agreement, disclosure document, and other key documents. Given this, you’ll need time to review these and get advice.
Step 2: Take your time
You may hear that that you have 14 days to sign the franchise agreement once you receive it, but in fact, 14 days is merely the minimum amount of time. “The 14-day minimum disclosure period does not commence until you’ve received the franchisor’s disclosure document, the franchise agreement (in final form) and a copy of the Franchising Code of Conduct,” Keogh reveals.
Your disclosure document must include the costs of setting up and operating the business plus any limitations on your supply arrangements. “If the franchisor puts pressure on you to make a quick decision, you should consider this a warning sign to take extra care,” Keogh warns.
Step 3: Phone a (franchising) friend
Speaking with a friends and family about your aptitude as a franchisee can be helpful, but not nearly as helpful as speaking with former and existing franchisees. Their contact details can be found in the disclosure document. “Ask them some key questions such as how they find life as a franchisee? How many hours they work per week? Has it cost more than they expected? What would they do differently next time? And finally, whether their expectations before entering the franchise were met?” Keogh suggests.
It also very important to speak with former franchisees who have left the system. Contact details of former franchisees (who left up to three years ago) are also in the disclosure document. “This is very important for any former franchisees who were located at the site or in the territory that you are considering. Be sure to ask them why they left the system,” Keogh says.
Step 4: Get advice from independent professionals with franchising experience
“Through our work regulating franchising, the ACCC has found that too many prospective franchisees do not obtain legal, accounting, or business advice before signing up,” Keogh says. “This is a real concern because professional independent advice can often help reduce the risk associated with such decisions. We strongly encourage prospective franchisees to get qualified advice from professionals with franchising experience.” Before choosing an advisor, make sure that you ask them about their franchising experience. Remember, franchising is a complex business structure, you want the right people in your corner.
Just because an opportunity sounds good on paper, or because you like the brand, it doesn’t mean that the it will be right for you. The only way to truly measure the value of a prospective franchise venture is through a thoroughly detailed due diligence process.
Consider these steps carefully and make sure you are constantly assessing your own personal, financial and technical ability as a candidate.