I often get enquiries from people who are thinking about buying into a franchise, or who have already found a franchise they want to join and are working out what happens next.
One of the things that can make a franchise attractive is that much of the business is already packaged for you. The brand, operating systems, suppliers, marketing and business model are already established. Compared with starting a business from scratch, it can feel like a simpler way to become a business owner.
But buying into a franchise is not necessarily a simpler transaction than buying an ordinary business. In some respects, it is considerably more complicated.
When you buy a standalone business, the central transaction is usually the purchase of the business itself. With a franchise, you are not just buying a business. You are also entering into an ongoing relationship with the franchisor, taking on rights and obligations under a franchise agreement, and dealing with other arrangements that may include a lease or occupancy licence, guarantees and security documents, and the contract for the purchase of the business and its assets.
Those documents do not operate independently. They are interconnected, but they may have different terms, different termination provisions and different consequences when the relationship comes to an end.
That is where much of the risk in a franchise transaction lies. A document can look reasonable when read on its own, while the combination of documents can create obligations or risks that are much more significant.
Understanding how those documents fit together — and, importantly, how they bind you into the future — is therefore a major part of assessing whether a franchise is the right investment for you before you sign.
A typical franchise entry involves four legal arrangements
There is the franchise agreement itself. There is the premises arrangement, which is usually either a lease in your own name or a licence to occupy premises the franchisor holds under a head lease. There is often a purchase of the business assets, either from the franchisor or from an outgoing franchisee. And there are the securities, meaning personal guarantees, bank guarantees, and sometimes a mortgage or a charge over assets you already own.
Each of these has its own term, its own termination rights and its own consequences on exit. A franchise term of five years sitting over a lease of ten years is a common combination and a poor one. So is a guarantee that survives the end of the franchise relationship. Reviewed one at a time, each document tends to look manageable. The exposure sits in the combination and in the mismatch between the dates.
The Franchising Code governs the process of entry, not the quality of the deal
The Code is the starting framework for entering a franchise. Before you commit, it requires the franchisor to give you important information about the franchise and the business.
Pre-entry disclosure runs in stages. An information statement in the prescribed form comes first, then at least 14 days before you sign a new agreement or make a non-refundable payment you must be given the current disclosure document, the franchise agreement in the form in which it is to be executed, and a copy of the Code. That period gives you time to consider the information and obtain advice before you commit.
The Code also gives franchisees a short cooling-off period after entering into the franchise agreement or making a payment, subject to the circumstances and requirements in the Code.
What the Code does not do is tell you whether the deal is a good one. A franchisor can comply with its disclosure and timing obligations and still offer you an agreement that will not make you money.
The Code covers more arrangements than you might imagine
The Code applies according to substance rather than label. An arrangement described as a licence, a distributorship or a supply agreement can still satisfy the statutory definition of a franchise agreement. If you operate under someone else’s system, mark and operating controls, the question of whether the Code applies to you is worth asking even if nobody has used the word franchise.
Don't skip the disclosure document
The disclosure document contains important information about the franchise system, including current and former franchisees, relevant legal proceedings and the franchisor’s financial and business details.
The list of franchisees who have left the system is particularly valuable due diligence for a prospective franchisee. Speak to current franchisees about their actual costs and how the franchisor behaves when a site underperforms. Ask former franchisees why they left and what they recovered.
The costs and the exit
Fee structure matters less than how the fees behave when revenue falls. A royalty calculated on gross revenue is payable whether or not the outlet is profitable. Minimum performance obligations, compulsory marketing fund contributions and compulsory supply arrangements have the same character. They are fixed costs described as participation in a system.
Territory is the next thing to read closely. Exclusive, non-exclusive and “primary marketing area” are different animals. A clause allowing the franchisor to serve your area through online ordering or corporate accounts can hollow out an exclusive territory without breaching it.
Then read the end of the agreement before you read the beginning. There is usually no right of renewal, only an option conditional on the franchisor’s satisfaction. Refurbishment obligations, transfer consent, and what happens to the customer list and the site when the term ends all determine whether the business you are buying is one you can ever sell.
Buying an existing franchise means buying a business with a history
If you are buying from a departing franchisee, you need to account for everything that attaches to an ordinary business sale. Plant and equipment in the condition it is actually in. Stock counted and valued at settlement. Employees, and whether their engagement is a transfer of business, which affects accrued entitlements and continuity of service.
You also need to investigate the business’s history before you buy it. Unpaid supplier accounts, an equipment lease nobody mentioned, and a security interest registered over the assets you think you are buying can all create problems after settlement.
The franchisor sits across the sale as well. Consent to transfer is required, the incoming franchisee is usually asked to sign the current form of franchise agreement rather than inherit the vendor’s version, and the remaining term can be shorter than the payback period on the price you are paying. Turnover figures supplied by a vendor are the vendor’s figures. They are a starting point for enquiry, not a basis for a decision.
The lease is often the largest liability in the transaction even if it's not in your name
For a retail site, the lease can commit more money over its life than the franchise fees ever will. Where you take the lease directly, an assignment in New South Wales engages the Retail Leases Act 1994 (NSW), with its own disclosure obligations and the landlord’s consent requirements.
Where the franchisor holds the head lease and grants you a licence to occupy, the position is different. You are not a party to the head lease or in a direct contractual relationship with the landlord. Your right to occupy depends on the franchisor’s rights under the head lease, so it is important to understand the terms of that lease and how they affect your occupancy.
Sitting alongside the lease are the securities. A bank guarantee, a personal guarantee, a mortgage over a home and a make-good obligation at the end of the term are liabilities that can outlive the business if the business fails.
What you're told matters too
Don’t rely only on what is written in the franchise agreement. If the franchisor or its representative tells you that a business should achieve a particular level of sales or profit, or makes an important statement about the costs or performance of the franchise, record it and ask for it in writing.
This is particularly important when you are deciding whether the business can support the price you are paying and the costs you will take on. A projection or representation that nobody is prepared to confirm in writing should be treated with caution.
What to think about before you sign anything
First, get the documents early. Ask for the disclosure document and the agreement before you pay any holding deposit, and take advice while the franchisor still wants your business rather than after you are committed. Keep a record of when they are provided.
Second, treat the consideration period as the minimum and not the allowance. Nothing prevents you from asking for longer.
Third, use the franchisee lists. Speak to people currently in the system and people who have left it.
Fourth, put every earnings representation in writing. If a figure was mentioned in a meeting, email it back and ask for confirmation of the figure and the basis for it. A projection nobody will repeat in writing is telling you something.
Fifth, have the franchise agreement, the lease or occupancy licence, the sale of business contract and the guarantees reviewed together, at the same time, by the same adviser.
Sixth, settle the ownership structure and the guarantees before signing rather than after. Who contracts and who guarantees are questions with consequences that last years.
Seventh, model the business on the franchisor’s cost structure and your funding, not the vendor’s. A vendor operating without paying himself a wage produces figures you cannot replicate.
Advising on franchise entry and business purchases is a core part of my practice. The work is most useful before a deposit is paid, while the terms can still be negotiated and walking away is still cheap.
If you are considering entering a franchise or buying an existing franchise business, get legal advice before you sign or pay a deposit.
This article provides general information only and is not a substitute for legal advice. Every franchise transaction is different, and you should obtain legal and financial advice about your particular circumstances before entering into a franchise agreement or purchasing a franchise business.