Franchising is regulated by a mandatory Franchising Code of Conduct, which the ACCC oversees. Under the Franchising Code, a franchisor must provide a prospective franchisee with a disclosure document. This document contains critical information, including the likely expenses involved in running the business, whether your client will have an exclusive territory and details of what will happen at the end of their agreement.
Earnings information
If a franchisor provides your client with an earnings forecast, they must also provide
an explanation of how these figures were calculated, including the facts and assumptions on which the figures are based. This will help you advise your client on the likelihood of achieving the projected earnings.
If the franchisor provides actual historical figures from one or more of their franchises, think about whether those franchises are comparable to the one your client is considering in terms of location, demographics and other factors.
Your client should also try to verify any figures provided to them. They can do this by talking to past and current franchisees, whose contact details should appear in the disclosure document.
Potential expenses
Most franchisees understand that they will be required to make a significant upfront payment and then pay ongoing fees to the franchisor. Check to see exactly what royalties and other fees your client will be expected to pay. Are the fees a percentage of gross or net turnover?
A franchisee may also be asked to make outlays they did not expect. For example, many franchise agreements allow the franchisor to require the franchisee to upgrade equipment, attend training or undertake a major store refurbishment. Will your client be able to afford any such unexpected expenses?
Territory
A franchisor must disclose whether a franchisee will have an exclusive territory. If your client does not have an exclusive territory, there is nothing
preventing the franchisor from selling another franchise or setting up their own store in close proximity. If this happens, your client’s profits could be affected.
Many franchise systems also have an online delivery mechanism. Will your client receive income from any customers in their area who choose to buy online rather than through your client’s shop front?
Renewal of franchise agreement
Franchise agreements run for a set term, usually five or 10 years. The Franchising Code does not give franchisees an automatic right to renew their franchise agreement when that term comes to an end. It is therefore important to consider whether it’s possible for your client to recoup their investment (and make a reasonable return) within the initial term – just in case the franchisor decides not to renew the agreement.
Crunch the numbers
Most importantly, sit down with your client and prepare a sample profit and loss statement based on all the information you have, which includes both best- and worst-case scenarios. This should give you the clearest indication of whether it’s a good investment for your client.
