Buying into a franchise is an exciting time, but you want to be sure that you are making a good commercial decision. Here are six important things you should do to ensure you make a wise investment with your hard-earned cash.
1. Do the research
Just because you like the product doesn’t mean buying the franchise is a good business decision. You need to get as much information as you can about current and likely future demand for the franchise’s goods or services.
Ask the franchisor for any data on sales, outlets, growth, marketing plans.
Talk to existing franchisees.
Consider the category the franchise product falls within (for example, fast food outlet) and research trends in the category.
Assess how the franchise brand is positioned in the category, and whether it is outperforming or underperforming the category.
And remember, even if there is strong demand at the moment or in the past, this does not guarantee strong ongoing demand.
If buying from an existing franchisee, request their financial statements, monitor the customer flows, and ask to work in the business for a period to understand the business opportunity better.
2. Read and understand the documents
It is critical that you read and understand all the documents provided to you, including the franchise agreement. Be sure you fully understand the operational and financial obligations you will be under if you purchase the franchise.
Take particular note of the contractual rights of the franchisor, such as rights to determine sources of supply and supply prices, control over marketing and advertising, ability to direct the way in which goods and services are delivered.
You also need to be clear on the grounds on which either party may terminate the contract.
The franchise agreement is a binding legal contract once signed. Given the amount you are thinking of paying for the franchise, it makes very good sense to pay for good professional advice on the terms of the agreement. Professional advice can save you from making a very bad and costly business decision.
3. Know your obligations, strengths and weaknesses
The franchise agreement will define what aspects of the business are your responsibilities and what aspects are the franchisor’s responsibilities. All franchise arrangements are different. You need to be clear about what your obligations are and whether you have the skillset to perform those obligations.
You may be great at customer service but not understand basic financial management or accounting. If the franchisor handles all the financial and accounting requirements and provides the system for you to use, you will be more capable and likely more successful than if the financial management is left entirely to you.
Consider carefully whether you have the necessary skills to do all the things required of you in the franchise. If not, you will need to factor in the costs of outsourcing those functions if you proceed with the purchase.
4. Analyse the numbers and assess the risks
You are not buying a job when you purchase a franchise, you’re buying a business opportunity. It’s your responsibility to make the franchise successful within the terms of the agreement. You must thoroughly understand the commercial elements of the franchise agreement.
What determines what you must pay to the franchisor once the franchise is operating? If the business is not as successful as you hope, does this alter the amount you must pay the franchisor?
What financial aspects of the business can you control? If the franchisor controls the price of supplies and the price of goods and services you offer, the amount of cash remaining to pay yourself, your staff, rent and other costs may be uncomfortably squeezed.
Do you have exclusivity in a locality? If not, competing franchises may be established nearby, significantly reducing your potential customer base.
Get professional financial advice to help you understand the commercial aspects of the franchise agreement, and assess the financial implications if key variables change.
5. What are your exit options?
What are your medium and long term objectives? If you plan to sell the franchise once you’ve built its business success, be clear on your contractual rights to do so, and any limitations or requirements set by the franchisor. The longer the term of the franchise remaining, the more valuable the business is likely to be.
Does your agreement give you the option to renew the franchise agreement after its term is complete, or (more typically) does this rest with the franchisor?
If your franchise operates from leased premises, remember that an effective exit will require an exit from both the franchise agreement and from the lease – two separate legally binding contracts which may be with two different entities.
And if the business is not going well, what does the agreement say about the terms on which you may terminate the agreement?
6. Don’t be pressured into signing
And finally, be prepared to walk away if pressure is on you to sign up, particularly with claims that “the opportunity will be gone tomorrow”. All sorts of promises and assurances may be given, which will mean nothing once the agreement is signed.
Reputable franchisors will encourage you to seek professional advice and spend time understanding the opportunity.
The Victorian Small Business Commissioner provides a quick, low cost and effective dispute resolution services for business-to-business disputes, including franchise disputes. For more information visit www.vsbc.vic.gov.au