One of the main attractions of buying a franchise for new entrants to the small business community is that there is usually less risk associated with buying a franchise in an established franchise network that has achieved substantial brand recognition in the marketplace. However, as with setting up any new business, many issues must be considered prior to making the decision and signing any agreements to buy the franchise.

The following are five things that a prospective franchisee should know before buying a franchise.

1. Choosing the correct business structure

There are a number of different business structures which a franchisee can adopt: sole trader, company, partnership or trust or a combination of these.

A decision as to the business structure to be adopted by the franchisee needs to be made early on and certainly before signing the franchise agreement. Some of the reasons for adopting the correct structure right from the outset include, minimising personal risk, protecting personal assets and making the purchase and the subsequent sale of the franchised business more tax effective. Prospective franchisees should seek both legal and financial advice in relation to the correct structure.

The franchisor may impose restrictions on the structure that can be adopted. There are some systems that refuse to allow partnerships or silent/passive investors.  Other systems insist on the owner/operator owning the franchise as a sole trader. Prospective franchisees should, therefore, check with the franchisor before setting up any structures.

2. Conducting due diligence

All prospective franchisees should do their homework, including obtaining information about:

• the particular franchise network and the franchisor’s reputation in the market place;
• the expansion plans of the franchisor;
• the relationship between the franchisor and its franchisees – this can easily be ascertained by talking to other franchisees within the franchise system;
• any current or threatened legal proceedings against the franchisor;
• the total amount the franchisee will need to invest in setting up the franchised franchise;
• the location where the franchise is to operate from a fixed site;
• if the prospective franchisee is considering purchasing an existing franchise then the prospective franchisee should request from the vendor historical trading information and examine the financial reports of the franchised business.

3. Reviewing the franchise documents

A prospective franchisee should receive from the franchisor a disclosure document in the form prescribed by the Franchising Code of Conduct, a copy of the Code and a copy of the franchise agreement the franchisee will be asked to sign. Under the Code these documents must be provided at least 14 days before the franchisee signs the franchise agreement or makes a non-refundable payment under the franchise agreement. A prospective franchisee should read these documents carefully and legal advice should also be sought.

The franchise agreement is the most important document in the suite of documents provided to a prospective franchisee as it will govern the legal relationship between the franchisor and the prospective franchisee for the duration of the term of the franchise.

Some of the clauses within the franchise agreement that should be given a more careful consideration include:

• the territory (if any) granted under the franchise agreement, specifically whether it is exclusive or non-exclusive;
• the duration of the franchise agreement including the initial term and any renewal term.  A franchise does not continue for ever.
• the fees payable;
• any minimum performance criteria;
• the circumstances in which each party can terminate the franchise agreement; and
• restraints following the end of the franchise agreement.

4. Take notes in preliminary meetings with franchisor

A prospective franchisee should take comprehensive notes in each meeting or discussion with the franchisor or its representatives both prior to and post entering into a franchise agreement with the franchisor.  Any representations or promises made by the franchisor before the prospective franchisee enters into the franchise agreement should be reflected in the franchise agreement.

This may become crucial in the event of a dispute with the franchisor years later and after the franchise agreement has been signed and after the franchised business has been operating for some time.  If a promise, representation or concession has not been reduced to writing it will be difficult to later prove.

Detailed notes will also assist a prospective franchisee’s advisers in giving advice in respect of the franchise documents.

5. Cooling off right

One important matter that is often overlooked is that once a franchise agreement has been signed or money has been paid pursuant to the franchise agreement, the prospective franchisee has a “7-day cooling-off period”.  This means that the prospective franchisee has 7 days within which he/she can withdraw from the franchise agreement.  This cooling off right does not apply upon renewal, extension or transfer of a franchise agreement.