Before you invest in a franchise it is wise to understand exactly what is in the agreement and what the system will offer you, advises Dr Michael Schaper, deputy chairman of the ACCC.

Buying a franchise can be a big investment. It usually involves a substantial upfront payment, followed by ongoing fees, royalties and other expenses. Before you make this kind of financial commitment, it is critical that you understand exactly what you are getting yourself into.

What information should you get?

Under the mandatory Franchising Code of Conduct (the Code), a franchisor must give you a disclosure document at least 14 days before you sign an agreement or hand over any non-refundable money. You should also receive a copy of the franchise agreement in its final form and a copy of the Code.

The disclosure document includes, among other things, a range of important financial information. It tells you how much money (if any) you will need to contribute to the franchise system’s marketing fund. It details your start-up costs, including any equipment, fixtures and stock you must purchase, as well as the working capital you will be expected to have available to you.

The disclosure document also sets out any other recurring or one-off payments you will need to make that the franchisor is aware of or can reasonably foresee, and warns you if there is a possibility of significant future capital expenditure (for developments such as rebranding or store refurbishment).

The franchisor must also disclose any requirements to enter into a lease, sublease, licence or other occupancy agreement, as well as the conditions of any financing arrangement that the franchisor or its associate offers to you.

End-of-term arrangements must also be disclosed, including whether you will have an option to renew or extend your franchise agreement or enter into a new one; whether you will be entitled to an exit payment at the end of the agreement and, if so, how that payment will be determined; details of the arrangements that will apply to unsold stock, equipment and other assets; and whether you will have the right to sell the business at the end of the agreement.

Many franchising disputes arise in relation to the termination by the franchisor of a franchising arrangement, so great care should be taken to negotiate fair terms in this regard.

It is important to note that the franchisor is not required to provide you with any earnings information. However, if earnings information is provided, it must be based on reasonable grounds. And if it is provided in the form of a projection, the facts and assumptions relied on to make that forecast must also be disclosed.

If a franchisor makes verbal earnings representations to you, ask if they can confirm these representations in writing. This will help avoid any misunderstandings down the track.

The disclosure document must include a statement from the franchisor’s directors as to whether there are reasonable grounds to believe that the franchisor will be able to pay its debts as they fall due. This statement must be signed by at least one director and either supported by an independent audit or copies of the franchisor’s financial reports from the last two financial years.

What should you do with the information?

Prospective franchisees should not make a decision to buy a franchise based solely on the information the franchisor has given them. It is important to make additional inquiries and seek professional advice.

Seek advice

Before you enter into a franchise agreement, you will need to give the franchisor a signed statement that you have received advice from a legal adviser, a business adviser and an accountant (or have decided not to). You are strongly encouraged to seek advice from professionals with franchising experience.

Talk to your accountant about whether the earnings figures you have been given (if any) are achievable. Ask your accountant to prepare two profit and loss statements – one with a best-case estimate of sales and the other with a worst-case estimate – that include all the expenses disclosed in your disclosure document. Will you be making a profit in both scenarios? Will you be able to pay yourself a decent wage? If the franchise agreement is for a fixed term (typically five years), and there is no guarantee that it will be renewed, will you be able to recoup your investment (and make a reasonable return) within that term?

Ask your lawyer to look at your franchise agreement and bring any unfavourable terms to your attention, for example, a clause that allows the franchisor to terminate your franchise agreement even if you haven’t breached it, or a clause that requires you to maintain a certain debt to equity ratio. You should take steps to renegotiate those particular terms with the franchisor.

Talk to other franchisees

Talking to other franchisees will give you the best insight into how the system actually operates. Your disclosure document should include the contact details of current franchisees, as well as franchisees that have left the system in the past three years.

Contact as many existing franchisees as possible, not just those the franchisor suggests, and ask them questions such as:

• Are they earning as much as they expected?
• Have they had any unexpected expenses?
• If they could go back in time, would they buy the franchise again?
• Have there been any disputes with the franchisor, and what were they about? How were they resolved?

When talking to past franchisees, you should also find out why they left the system.

Take a franchising pre-entry course

All prospective franchisees are encouraged to complete a course on franchising. More than 1900 people have already undertaken the free, online pre-entry franchise education program funded by the ACCC and administered by Griffith University. The five-module course includes a detailed explanation of the financial aspects of franchising. It can be accessed at www.franchise.edu.au/pre-entry-franchise-education.

Tread carefully

Most franchisors will be honest with you, but be careful of franchises that look too good to be true – they probably will be. Be wary of claims that you can make large amounts of money with little effort, and steer clear of franchisors who are unwilling to provide you with anything in writing.

The Australian Competition & Consumer Commission (ACCC) is responsible for promoting compliance with the Franchising Code and the Competition and Consumer Act. The ACCC has several franchising publications containing useful information for prospective franchisees, including a Franchisee Manual and a DVD about the Franchising Code. These are available online at www.accc.gov.au/franchising or by calling the ACCC’s Small Business Help line on 1300 302 021.