Thinking of investing in a Franchise? Consider the important factors to look out for in the franchisor’s disclosure documents.
Key Takeaways
- If a franchisor is not disclosing important information or reports to support its claim, it is a clear warning sign to ask further questions and investigate into the business operations.
- Upfront costs, day-to-day expenses for operating the franchise, and any significant costs related to the business are important to consider and obtain clear information on before entering into a franchise agreement.
- Be sure to have your accountant and solicitor consider the financial reports and disclosure documents and provide advice to you.
- Liaise with your franchisor to clarify your questions and negotiate amendments to the franchise agreement.
When you are considering becoming a franchisee, a franchisor must disclose important information about the franchise before purchasing it, which is normally provided in a disclosure document. This information is critical to you and may cause you to question whether you buy the franchise.
Here we set out some critical information that should be covered in the disclosure document and the warning signs to look out for in each.
- Franchise History
- Information on how long the franchise has been operating, and the experience of the managers of the franchise.
- Whether any dispute between franchisors and franchisees occurred. This can be raised with the franchisor who may provide further insight into the issues. This will allow you to understand the level of support or communication in the franchise system.
- Use the above information to search the people running the business, and any other businesses the franchisor officers were involved in.
- Look out for gaps in the history of the business operation, minimal experience in running a franchise business, and high or frequent levels of dispute.
- Former Franchisees
- Information and contact details for former franchisees could assist you in understanding why someone decided to leave the business, how many years they were in the business and advice.
- Look out for whether no contact details are available for former franchisees, as this may be a sign that the franchisor does not want you to contact a former franchisee.
- Litigation
- The history of the litigation or disputes between the franchisor and franchisees and provides further insight into the relationships within the system.
- Do the directors or franchisors have a history of not complying with the law, or history of debt. Have they been in proceedings for insolvency, bankruptcy or any involvement in crime?
- Pay attention to any recurrence or patterns of issues.
- Look out for whether the franchisor is in legal proceedings against the franchisees, or any directors or franchisors have become insolvent or bankrupt.
- Goods and Services
- Information about where you can purchase goods or services from to run the franchise, which may restrict you from purchasing from specific suppliers. Whether the franchisor receives any financial gain from these suppliers, like a percentage of each order made by its franchisees.
- This information is important to consider as the franchise would be uncompetitive, and you may not be able to take advantage of better deals for supplies.
- Look out for whether the rebates a franchisor receives from suppliers are shared with franchisees. Also, consider whether you could purchase the same goods or services from another supplier significantly cheaper and raise this with the franchisor before entering into a franchise agreement.
- Size and territories
- This information about where you can run the business, or who ran the business at this site before you are important. It may limit the area in which franchisees can operate or expand.
- Previous operators in this location or nearby may tell you more information as to why they stopped operating.
- Look out for whether there is no information about the previous owner’s site history (ask the franchisor for these details) and if the franchisor says you should not speak to previous franchisees.
- Costs and expenditure
- The start-up costs and running of the business costs are critical information on whether you can afford it and make money from the business. Capital expenditure should be disclosed such as its timing and nature of the capital spending, and the reasons for such expenses.
- Additional fees and costs, like marketing fees during operation, fees payable before and after the franchise agreement is in place, for example replacing equipment, refurbishing premises, and branding. You can ask for further details from the franchisor on required expenses, or any significant one-off costs.
- You can ask other franchisees questions about the running of their businesses and the costs they incur.
- Look out for whether there are no amounts listed for the cost of wages, rent or stock, or whether you are not able to determine the costs of setting up the business. Whether there is any supportive evidence to show how much money the franchisor is claiming the business can make.
- Look out for whether there are exact details of what marketing is done, and whether the franchisor contributes to the marketing fund equal to franchisees.
- Ending Franchise
- Information about when the franchise ends, or what happens when the franchise agreement is terminated. Whether there is an option to renew or extend the term of the agreement.
- Whether there is an option for you to sell your franchise business after or during the term of your agreement with the franchisor.
- Consider whether there is any restraint of trade after the end of the agreement. Restricting you from operating a similar business within a certain distance from the franchise location, for a specific period. This is critical for you to consider and discuss with your solicitor before entering into a franchise agreement.
- Look out on whether it is not clear whether you are entitled to a further term, as you may invest money and renovate the business and not be granted a further period to operate the franchise.
- It is important to look out for terms limiting where or how you can work after the end of the term, which seem unreasonable and may affect your ability to work and make a living after the franchise agreement ends.
- Dispute Resolution
- Consider whether there is a dispute resolution mechanism. Importantly it allows you to attempt to resolve a dispute via a formal process before the franchise agreement ends.
- Ensure that you understand both how disputes will be resolved and the amount of time you have to rectify breaches of the franchise agreement
- Look out for whether the franchisor does not agree to have an option of binding arbitration in the event of an unresolved dispute.
- Financial details of Franchisor
- Statements and reports about the franchisor’s financial circumstances and the stability of businesses should be included. This includes profit and loss statements and balance sheets.
- If no financial report is provided to you request this from the franchisor, as it may show the business is struggling.
- Provide all these reports to your accountant or business advisor to obtain advice.
If you are considering entering into a franchise agreement, it is important to have a lawyer review this for you and obtain legal advice on your rights and obligations. Contact us today to provide you with advice on your franchise documents, at (02) 9189 5288.
Craig Higginbotham and Nicole Sarraf
13 December 2024
