FRANCHISING
By the Entrepreneur Business Centre
What to look for when buying a franchise
Recent years have seen the rapid expansion in Australia of a phenomenon known as franchising. In
fact, it is almost impossible to drive down any main street in Australia today without passing a
franchised business. Currently it is estimated that the franchise sector accounts for nearly four
percent of existing business numbers, and a massive 30 percent of retail sales volume. Between 1987
and 1994 alone, Australian franchised sales grew from just over $14 billion to a staggering $42.7 billion
per annum (according to the Australian Bureau Of Statistics) - and the growth is still continuing. Fuelling
this exponential sales growth has been the emergence of over 700 new franchise systems, a huge
increase from the 184 opportunities available in 1988.
Today there is no shortage of advertised franchise opportunities. Naturally, with such a differing array of
opportunities to choose from, finding the right franchise for you is often a daunting task. You only have
to look at the business opportunities section of various newspapers and magazines around Australia to
see that supply is far outstripping demand. For you, the potential franchisee, making the right decision in
such a climate is imperative - your livelihood depends on it. To make the right choice though, requires
you to be fully informed and armed with the tools to help make your decision a successful one.
What is franchising?
When a business licenses its trade name and operating systems to a third party in exchange for a
payment, and exercises some control over the operation of that third party, the business generally is
defined as a franchise. In order to understand franchising, it is important to recognise that McDonald's
does not "franchise" hamburgers nor does Midas "franchise" mufflers. What they both franchise is a
business system-and it is that system that delivers the products or services. It is the entire method of
doing business (the name, the product, the decor and the methodology of delivery) that is franchised.
While sophisticated investors are becoming a major force in franchise ownership, it has been the
individual, investing in a franchise opportunity, that has fuelled franchising's growth. Franchisees
typically express their reason for buying a franchise as a desire to achieve the Great Aussie Dream of
financial security and independence.
Franchisor control
For a franchise system to be successful, the franchisor must control the system, and the franchisee
must follow the methods laid down by the system. The principal reason for this control is to safeguard
the public's ability to rely on the franchisor's trademark as an indicator of the system's products or
services, knowing that these products or services will be delivered consistently from location to location.
In simple terms, it's knowing that a Big Mac is a Big Mac, no matter which McDonalds outlet you
purchase it from. The public becomes accustomed to a certain level of quality and consistency from
brand-name franchises, and it's this brand identification which makes it easier for new franchisees to
compete with well-established independent and chain operations. Another reason for the franchisor
maintaining control is to protect the franchisees themselves, who are reliant on the franchisor ensuring
that other franchisees do not do harm to, or diminish the value of the business.
Considerations when buying a franchise
Your decision to purchase a franchise should be based upon two broad understandings:
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First: You should have an understanding of the advantages and disadvantages of franchising.
Second: You should have an understanding of the franchise you want, and how to evaluate it.
Franchisors, having survived their mistakes while developing the franchise and operating their prototype
locations, can guide their franchisees so they do not make the same mistakes. Upon joining an
established franchisor, franchisees receive comprehensive initial training in the operation of the
franchise system and in its product, services and methodologies. The franchisee benefits from the
operations manual, site selection, store design and continuing system support which would not be
available had they started independently. They not only have their franchisor as an experienced partner
from whom they can get answers, they also have the network of other franchisees that can provide
added assistance in the continuing operation of their business.
In essence, many of the major stumbling blocks which could lead to failure are removed by a good
franchisor. These franchisors prepare their franchisees for the business and then continue to support
them. A statistic often cited about small-business failure estimates that over 80 percent of independent
small businesses fail in the first three to five years. A recent study conducted by Edith Cowan University
in Western Australia shows that franchisees are 2.5 times less likely to fail than independent small
businesses.
"Failure," as commonly used in franchising, must be carefully understood by the prospective franchisee.
Business failure refers to the closing of the location's doors, on a permanent basis. In a franchise
system,statistics on failures do not include franchised locations which are repurchased by the
franchisor, and continue in operation as a company-owned location, or as a location resold and
operated by a new franchisee , at times with a financial return to the original franchisee.
Franchisors will often acquire locations for strategic reasons, which may include a desire to operate
more company-owned locations or because a franchisee is not performing to standards. Instead of
terminating the relationship through litigation, the repurchase of a franchise may be the most attractive
route. On the other hand, franchisees often sell or abandon their businesses because they have not
received the rewards they expected, or for other reasons including retirement or the desire to change
their life patterns. Therefore, it is important when discussing failure rates with any franchisor that you
ask about reacquisitions and transfers. Request the names of those franchisees involved in the
transactions and determine for yourself why the businesses were sold.
Critical decisions
Ensuring that you have enough working capital to sustain you in the start-up period is crucial, and poses
a major risk for new businesses. Will the location selected provide the business with sufficient
customers? Is the size of the location too large or too small? Is the rent too high? How many employees
are required, at what times of the day, and how much should they be paid? Is the equipment selected
the best for the operation and is the price for the equipment fair? These and hundreds of other
questions must be considered and answered.Well-developed franchisors have experience in starting
and operating the business the franchisees are going to operate. They can guide their franchisees as
they make these critical decisions. That experience lessens the franchisee's chances of making
mistakes, helps them to avoid underestimating their capital needs and, therefore, reduces their risk of
failure.
The difference in failure rates between franchises and independent businesses is an impressive factor
to consider. Bear in mind though, that independent businesses do not fail solely because of poor-quality
products or services. They often fail because they could not anticipate their capital requirements, and do
not have the experience or resources to fully analyse the risks they face.
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Advantages and disadvantages
Franchising is not a perfect vehicle and has advantages as well as disadvantages. It is important for
new franchisees to recognise that many apparent disadvantages inherent in franchising may, however,
also be advantages. One factor that is often seen as a disadvantage is the public's perception of the
system as a chain. When they receive great service at one location, they assume they will get great
service at all locations. The reverse is also true. You will be judged not only by your performance but
also by the performance of all of the other franchisees.
Therefore, when evaluating a franchise, make certain that the franchisor has the right in the agreement
to enforce the system's standards and has strongly exercised those rights. You need assurance that
performance standards will been forced and enforced uniformly.
Limitations on territorial rights may restrict your market and income, but they allow other franchisees to
contribute, as you will, to the system's advertising fund and provide the critical mass needed for the
system to compete effectively against the competition. The possibility of being terminated for failure to
follow the system, and the franchisor's right to approve the people to whom you may want to sell your
business, protects you from other franchisees who may not perform as well as you and to whom your
success is tied. Therefore, some of the restrictions placed on a franchisee can also constitute an
advantage for the franchisee.
A prospective franchisee needs to have realistic financial expectations. Having unrealistic expectations
is the greatest potential disadvantage of starting any new business, not just a franchise. Advantages
and disadvantages of franchising will be further discussed in the following chapter.
Evaluation - industry and self
Select an industry that meets your personal needs and likes. If working twelve-hour days, seven days a
week is not your idea of fun, make certain the franchise industry you select offers better hours. If you
need a certain income each year to support your family, make sure that the other franchisees in the
system you select enjoy that level of return. Your answers will come from two main sources: personal
meetings with the franchisor, and your contact with other franchisees already operating in the system.
Begin your examination of the offerings in the industry that meets your needs. The obvious choice may
be the well-established company with hundreds of franchisees, but keep in mind that many of the newer
business opportunities have entered the market with innovations that older systems may find impossible
to incorporate. Also, older systems may be less flexible should you want to negotiate any terms of the
franchise agreement. Newer systems may be more willing to negotiate.
Again, this may be a double-edged sword. Franchising's strength is in its consistency. Should the
franchisor be willing to negotiate with you on significant issues, they are likely to do so with others. Be
wary of franchisors offering concessions which seem "too good to be true". This may be an indication of
cash flow problems within the system. Even if this isn't the reason, bear in mind that another term for
flexibility is inconsistency, and inconsistency is not what you or the public wants from a franchise
system.
Contact each franchisor in the industry and obtain their information package. Read it carefully and write
down your questions about the companies. Remember, a glossy brochure and a great franchise
salesman are not good reasons to select any company.
Try to understand the philosophy of the company and identify their customers. Compare their services
and their fees with those of others in the same industry. Lower fees should be the least important
reason to select one company over another. If one franchisor charges high fees but provides the best
services, the high fees are a bargain. If the fees are low and the services are inconsistent or leave you
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to operate independently, why buy the franchise in the first place? Once you have received and
reviewed the information about the companies you contacted, select those which meet your criteria and
arrange to meet the management and staff. Allow the franchisor to introduce you to the system, the
services and the key personnel. Ask questions when you visit the headquarters and do not accept
superficial answers. Remember, the franchisor is likely to have a very polished interview process and
has been through this many times before. This is likely to be your first time.
Be prepared
Come prepared, with your questions written down. Do not hesitate to ask them. Do not be reluctant to
probe for further information. Buying your franchise is likely to be one of the most important personal
business decisions you will ever make, so you must base this decision on a firm foundation of
information.
Disclosure documents
At your first meeting with the franchisor you might receive a copy of the franchise disclosure documents.
The disclosure documents should provide you with a wealth of information on the franchisor and the
system. Areas covered by the disclosure documents should include: the management and key staff's
experience in managing the franchised business; its litigation and bankruptcy history; the cost of
opening a franchise, initial and continuing fees. The documents should include an explanation of the
relationship and responsibilities of the franchisor and franchisee, together with financial information on
the franchisor. They also should provide information on the number of franchises opened and closed
and, most importantly, a list of franchisees.
Regardless of how much you want to invest in the franchise, after meeting with the franchisor, you
should always review the offering circular with an experienced franchise lawyer or consultant and your
accountant. Good franchisors understand that this is a very important decision you will make. They
should not pressure you to buy their franchise until you are satisfied that the franchise is right for you.
Be wary of franchisors who pressure you to "sign up" before you are ready. Once you have made the
decision to go ahead and buy a particular franchise, the Franchising Code Of Conduct requires a
cooling-off period of a minimum of seven days from the date you are given the franchise agreement.
Use this time wisely and seek outside counsel and advice.
Talk to other franchisees
Call as many franchisees as you feel necessary before buying a franchise. Also, visit as many of the
franchisees as possible. Just because a franchisee is unhappy in the system, it is not always a solid
indication that the entire system is bad. In every franchise system, there may be at least one, or maybe
several, unhappy franchisees. See if their dissatisfaction is a widespread concern.
It is critical that you base your financial assumptions on many sources: the information available from
the franchisor, information obtained through your discussions with existing franchisees, information from
articles about the franchisor and the industry, and your visits and observations at the franchised
locations.
A final piece of advice
A final piece of advice in selecting your franchise is to suppress your emotions. Never buy a franchise
based upon the sizzle of the brochure or the salesmanship of the franchisor. Base your decision on the
quality of the investment and on the available facts. Make certain before you invest in a franchise that it
will benefit you both personally and financially.
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The above is an extract from EBC's Buying a Franchise guide and software package - a publication
written specifically to protect the interests of prospective franchisees. EBC has spent hundreds of hours
independently researching, collating and publishing what is arguably Australia's most comprehensive
guide to buying a franchise. The guide will take you step by step through the selection process, showing
you how to evaluate yourself and the franchise, provide you with checklists and all the important
questions to ask when doing your research, reveal common traps to watch out for and how to protect
your interests, and guide you in compiling and writing a professional business plan to help win over the
bank.
Now, it is up to you to select from the multitude of opportunities available. Purchasing a franchise is an
exciting decision to make. Take your time, complete your examination, ask thorough questions, do not
be intimidated... and select carefully.
The different types of franchises
As franchising has grown, its personality has evolved but its essential structure and purpose have
stayed intact.
Primarily, franchising fills the gap between two business parties, allowing them to maintain a
relationship where each has a valid interest in the other’s business. The extent of the rights and
interests of both parties is determined in a written contract that defines the type of franchise.
However, to clearly understand what a franchise is, you first have to learn about the different types of
franchises:
Product and trade-name franchises
Product and trade name franchises are primarily used to set up distribution networks for the franchisor
through dealer companies.
By franchising out the distribution of its products, the franchisor is able to control the way the dealer
company operates by restricting the sale of competitive products or the type of marketing that it can do.
In turn, the dealer, or franchisee, receives the recognition that accompanies a well-known firm. They
may also receive financial, marketing and managerial support from the franchisor.
Business format franchises
This has become the most popular type of franchise, and the one with which most people are familiar.
Under this arrangement, the franchisee is granted the name, the use of the products, the marketing
techniques, the systems, internal controls and operations procedures.
All the franchisee is doing is simply managing an established business - a total business concept which, in some cases, is a turnkey package.
The individual franchise is probably the most common type of business-format franchise. Under the
individual franchise, the franchisee is granted the right to operate a single unit in a single area using the
total concept of the franchisor.
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Affiliate or conversion franchises
Affiliate or conversion franchises are primarily used by a group of independent businesspeople within a
very fragmented industry in order to combine their resources to produce more visibility.
This is done by having each business affiliate with all the others under one name to create a franchise
network.
Under this system, all the companies are able to pool together their purchasing power, advertising clout,
and marketing abilities to capture a greater share of the market.
The affiliate companies are not legally bound to use the banner name of the franchise, which doesn’t
have to be a trademark or brand name. Many affiliates will, in fact, use the franchise name as well as
their own, as is the case with Century 21 Real Estate.
The variety and scope of franchising today is such that anyone planning on opening a business
dominated by franchising, or characterised by aggressive franchisor advertising, should at least
consider joining them, rather than beating them.
It is much easier to buy a franchise outlet than start an entirely new business franchise.
Unless you bring to the table a good deal of knowledge, expertise and marketing judgment, you may get
yourself into trouble by trying to compete with the veterans of the industry.
Franchisee and franchisor disputes
Extensive studies have revealed that a large percentage of disputes that arise between franchisor and
franchisee occur over the same stages of what has become known as the ‘E’ Factor – a simulated
model which identifies specific stages that every franchisor-franchisee relationship goes through.
The model was developed by Greg Nathan, a corporate psychologist who studied the behavioural
patterns of new franchisees and found that all of them tended to go through similar phases.
The reason for calling the model the ‘E Factor’ is fairly self-explanatory when you consider the six
stages of the progression:
1. The ‘Glee’ Stage
2. The ‘Fee’ Stage
3. The ‘Me’ Stage
4. The ‘Free’ Stage
5. The ‘See’ Stage
6. The ‘We’ Stage
What to expect
Each of these six stages is characterised by certain franchisee attitudes towards the franchise and the
franchisor.
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The Glee Stage: You are extremely happy with your new purchase and are looking forward to
building your future. You are incredibly obliging to the franchisor because you are able to
acknowledge that the franchisor is providing you with a great opportunity.
The Fee Stage: You are happy because you are making money, but you find it hard to part
with the royalty payments because it ultimately leaves you with less money in the till.
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The Me Stage: You start convincing yourself that your success has only come through your
own hard work. You believe that you can run the business more efficiently without the
franchisor’s input.
The Free Stage: The novelty has well and truly worn off. You constantly complain about
franchise restrictions and standards, question the validity of the operations manual, and
generally try to run the business your way to prove a point to the franchisor.
The See Stage: You begin to acknowledge the part played by the franchisor and the franchise
system. You begin to see the value of having a proven and standardised system to work with,
and you realise that you been making things difficult for the franchisor in recent times.
The We Stage:You are comfortable with the fact that the two of you need to work together in
order to achieve personal and managerial goals. You pass on ideas to the franchisor for
consideration and ask for assistance in areas that you are unsure of.
As you could probably guess from that progression, most disputes arise during the middle two stages –
‘Me’ and ‘Free’. It is during this time that franchisees are hard to get along with because of the
frustration with the restrictions placed on their ability to operate the business.
The system has always been in place, but a certain stage is reached where perceptions of the system
shift from positive to negative. This can lead to big problems and franchisors have to know how to deal
with disgruntled franchisees.
The ‘E Factor’ model is a simple way to understand the sequence of emotions that a franchisee
experiences, and gives franchisors the opportunity to plan for each separate phase.
The after-purchase relationship
The Franchising Code of Conduct applies to the franchisor/franchisee business relationship offering
certain protection and remedies. Having entered into the franchise agreement there are certain steps a
franchisor must take in the ongoing relationship.
Lease: A copy of the lease must be given to the franchisee within one month after the lease or
agreement to lease has been signed
Marketing fund: Prepare an annual financial statement within three months of the end of the
financial year. Have the statement audited by a registered company auditor within three
months of the end of the financial year. Give a copy of the statement to a franchisee within 30
days of the request. The franchisor does not need to comply if 75 per cent of franchisees agree
to waive this right.
Ongoing disclosure: The franchisor must disclose materially relevant facts to franchisees or
prospective franchisees in writing, within 60 days after the franchisor becomes aware of a
matter.
Disclosure: A franchisor must give a franchisee a current disclosure document within 14 days
after a written request by the franchisee. However, this request can only be made once in 12
months.
Transfer of a Franchise: A franchisor must not withhold consent, unless there are reasonable
grounds for not doing so such as the proposed transferee does not meet a reasonable
requirement of the franchise agreement, for the transfer of a franchise.
Dispute resolution: Adhere to the complain handling procedure outlined in clauses 29 and 30
of the Franchising Code.
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Association of franchisees: A franchisor must not induce a franchisee not to form an
association or not to associate with other franchisees.
Release from liability: A franchise agreement must not contain or require a franchisee to
sign, a general release of the franchisor from liability towards the franchisee.
Termination: Where a franchisee breaches a franchise agreement, the franchisor must not
terminate the agreement without reasonable notice, instead telling the franchisee how the
situation can be remedied and allowing the franchisee reasonable time (within 30 days) to
remedy the breach.
Where a franchisee has not breached the franchise agreement, the franchisor must give
reasonable written notice of the proposed termination and reasons for it to the franchisee. In
specials circumstances (clause 23 of the Code) a franchisee does not have to comply with
clauses 21 or 22 of the Code.
Dispute resolution
An issue that hopefully won’t arise during your time as a franchisee, but a very important one to
understand all the same, is dispute resolution.
Even though you may have analysed every aspect of the business before deciding to purchase, there is
always a chance that conflicts will arise, no matter how much you try to avoid them. Managing your
franchise relations is equally as important as managing the franchise business.
Without exception, every conflict that occurs between franchisee and franchisor can be blamed on a
breakdown in the communication chain. Ironically, formal communication between the two parties has
emerged as the most effective way to resolve disputes.
Common causes of disputes between franchisor and franchisee include the following:
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Inadequate training of franchisee, leading to inability to run business efficiently.
Inability of franchisor to manage system properly.
Franchisees not complying with the operations manual.
Inadequate guidance and support provided by the franchisor.
Problems with rent, leasehold improvements and site issues.
Franchisor unhappy about franchisee commitment and standards.
Franchisee unhappy with restrictive standards.
Default or non-compliance of the terms and conditions contained in the franchise agreement by
either party.
The best way to avoid getting involved in potentially harmful incidents like these is to build a mutually
trusting and understanding relationship with the franchisor.
Suspicion about the motives of each other, and the inability to appreciate the needs and expectations of
the other party will only cause trouble. This is why it is so important that you analyse the franchisor just
as vigorously as you analyse the business.
Even if you find the perfect franchise, if you don’t see eye-to-eye with the franchisor it might be wise to
back out, or you could end up regretting the move.
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Dispute warning signs
Signs that may indicate a clash is on the horizon, which apply to both the franchisee and the franchisor,
include the following:
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Making mountains out of molehills.
Reluctance or inability to answer questions.
Scape-goating or blaming individuals for bigger issues.
A drop in the level of commitment displayed.
Questionable motives.
Recurring problems linked to behavioural patterns.
Lack of trust.
Ignorance of needs and wants of other party.
Frequently asked questions
The following is a list of frequently asked questions concerning possible disputes that may arise
between franchisors and franchisees.
Can the period of tenure of my franchise agreement be altered? What recourse do franchisees
have if the franchisor seeks to shorten the franchise agreement?
The question of whether the length of the franchise agreement can be altered will be set-out in the
franchise agreement. As the original franchise fee is usually based on the duration of the agreement, an
attempt to change it may constitute unconscionable conduct.
If during the term of the franchise agreement the franchisee is concerned with variations to the
franchise agreement or to the franchise system, what approach should he/she take?
Firstly, concerns regarding the operation of the franchise system should be taken up directly with the
franchisor. If the franchisee’s concerns are not addressed, he/she should consider taking the matter up
with the franchise council that represents franchisees.
Can a franchisor seek access to the financial records of a franchisee of the franchised
business?
Yes. A franchisor can seek access to the financial records of a franchisee that relate to the obligations
of the franchisee under the franchise agreement.
Can a franchisor object to the price for which a franchisee sells its products? Are franchisees
able to offer discounts to customers in order to promote their business?
Franchisors are not able to stop franchisees discounting, but they are able to set maximum prices.
Specific legal advice should be sough on pricing matters.
Becoming a franchisee: the dos and don'ts
Franchising can provide a satisfactory entry into business for many people. You should be copying an
already successful and proven formula with training, advice and marketing provided by the franchisor.
However, keep in mind that you are making a substantial investment. Always investigate before signing
a contract and take heed of the messages of experienced professional advisers.
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The following is a list of the do's and don'ts of becoming a franchisee:
Do:
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Do read and understand all the documents yourself, including the fine print, and insist on
seeing actual figures of actual outlets, not just projections.
Do consult your bank manager, lawyer and an independent qualified accountant. If it is a
decent franchise they should have heard of it. The professional fees involved are a small
'insurance premium' to help avoid problems.
Do deal with the principals of the business – they are the people you are signing up with.
Do talk to existing franchisees of your own choosing – are they happy/profitable? What is the
ongoing service like? Would they join again?
Do join only a franchise that is a member of the Franchise Council of Australia and conforms
fully to its Franchise Code of Practice.
Do educate yourself on franchising. Go to exhibitions, read magazines and newspapers and
obtain a copy of the Franchise Council’s Franchisees’ Guide.
Don't:
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Don't get pressured into signing anything or parting with any money. A good franchise
agreement has a seven day 'cooling off' period.
Don't join a franchise unless you really like the business and the people. For several years,
you will be working harder than you have ever done before, so you had better enjoy what you
are doing.
Don't over-stretch yourself financially. Ensure you can meet the repayments, your mortgage
and your living expenses.
Don't join a franchise without company outlets and other franchisees. You are taking a much
bigger risk if you are the first franchisee or the business is unproven in Australia, despite its
possible success overseas.
Don't rely on advice from people who are not independent. Make sure you have your own
professional advisers – accountant, lawyer and banker.
Understanding the franchise agreement
A franchise agreement is the foundation of a strong franchising network, and is necessary because it
gives the franchisor and franchisee a clear understanding of the framework in which they must operate.
Of course, it must be fair to both parties. A franchise agreement:
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Ensures uniformity, which is one of the most important features of franchising
Establishes certain standards of operation
Protects both parties
Eliminates future problems and addresses many potential difficulties as they arise
Provides for remedies in the event of default
Is a binding legal agreement between franchisor and franchisee that sets out all the
responsibilities that exist between the parties.
A typical franchise agreement will be biased towards the franchisor, because it would have been written
by the franchisor with their own interests primarily at heart.
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As a prospective franchisee you should always read the franchise agreement thoroughly from front to
back, as it deals with matters that will directly affect you. Too often franchisees sign the agreement
simply out of haste and ignorance.
If something doesn’t make sense, get it checked by a Trade Practices lawyer or a franchise counselor.
Note: The Trade Practices Commission and the Franchising Code of Conduct can override the
Franchise Agreement.
Buying a franchise is a huge commitment and unless you totally understand all the legalities, issues,
rights and entitlements that fall within the framework of the franchise, you shouldn’t be willing to devote
any amount of time, energy or money to the business.
Elements of the franchise agreement
Although the actual content of franchise agreements differs from business to business, they all tend to
follow the same format and cover similar areas because the same issues affect franchisors right across
the board.
1. Parties to the contract
The agreement should stipulate whom the contract binds, that is, it should identify the
franchisor and the franchisee. All parties involved should sign the document, at which point
they are deemed to have read the contents of the document and are therefore bound by them.
2. Proprietor remarks
These refer to any use of the name or the contesting of the name, notifications to the
franchisor of others’ use of the name, compliance with the operating manual, the use of
product systems and designs, and sign requirements. Training and assistance programs
should be spelled out, as well as the fact that the franchisee must complete a training program.
The agreement should specify what kinds of continuing advisory services, promotional tools,
and marketing techniques will be made available to the franchisee.
3. Advertising
The franchisor should approve of all advertising copy, materials, packaging and promotional
materials. Some companies establish a national advertising fund and specify that a certain
percentage of the franchisees’ gross sales be spent on local advertising.
4. Operations manual
Provide for adherence to the operations manual, if there is one. The manual is the property of
the franchisor, and you must maintain its confidentiality. Franchisors will make provisions in
this section requiring you to adopt any new additions or revised concepts. The manual is
inherited by all franchisees, who must treat it like the bible and abide by its rules.
The franchise agreement should point out the existence of such a manual. If an operations manual does
not exist, then all matters relating to the day-to-day running of the business must be written in the
agreement. Hours of operation, procedures, methods and guidelines must be provided for.
Intellectual property rights
Intellectual property rights are generally granted to the you by the franchisor. The right to use
trademarks, logos, names, signs and systems is a basic need for a franchisee. Imagine buying a
Subway franchise and not being able to call it Subway! However complex, the nature of intellectual
property rights necessitates the need to formalise all such privileges bestowed on the you in the
franchise agreement.
Franchise agreement details
The following is a continued list of elements of the Franchise Agreement.
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1. Maintenance and repair of facilities
If a franchisor is going to establish a 15-year franchise agreement, they want to be sure that if
a facility needs painting in five years, it gets painted.
This section usually states that if the interior and exterior are not maintained, the franchisee will
be in default of the agreement.
2. Accounting and record-keeping
You must keep a complete record of all activity as prescribed. He or she must provide reports,
allow for inspection of records, and provide audited statements as required.
You will have to keep certain records such as weekly or fortnightly sales reports, and monthly
profit and loss statements.
Franchisors will want to be able to inspect your records through their area supervisors or
representatives. This is to ascertain that you are correctly reporting the activity of the business
and to ensure that you are not under-stating your sales and thereby cheating them out of
royalties.
There will also be a section providing that you give them annual, audited statements by a certified public
accountant, with interim statements.
1. Standards of quality
This is one of the most important aspects of the franchise. Without the establishment and
enforcement of quality standards, there is no franchise.
The franchise agreement must also establish the need for uniformity, which is crucial.
For example, a McDonald’s hamburger tastes pretty much the same whether you buy it in
Melbourne or New York.
Wherever you go, you can count on a uniform product, clean surroundings, and quality service.
That is the aim of franchising.
2. Exclusive or non-exclusive territories
The territory that a franchise operates in can be declared exclusive or non-exclusive by the
franchisor.
An exclusive territory declaration means that the franchisor cannot start up any other
franchises within that territorial boundary.
A non-exclusive declaration enables the franchisor to start as many franchises as they think
are necessary to service that area.
Generally speaking, non-exclusivity favours the franchisor, while exclusivity leans towards the
franchisee.
Status aside, the ability of the territory to support the franchise operation is the most important
consideration. As a franchisee, you should always research the area yourself (even if the franchisor has
previously compiled a feasibility study), so you can be sure that the base from which you will be
operating is adequate.
Franchise agreement considerations
Consider the following as part of your Franchise Agreement:
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System modification
Establishes the rights of the franchisor to modify the system if need be, but prohibits you from
unauthorised modifications. For example, an ice-cream shop franchise may not want
franchisees to sell fresh bread as well, while the bakery franchise operation probably wouldn’t
want franchisees to sell greeting cards.
Ongoing service and royalty fees
The Franchise Agreement establishes a service and royalty fee. When franchisors set royalty
fees, they must project the total direct and indirect costs of providing continuing services. They
then establish the percentage of gross sales they will charge franchisees to meet costs and
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attain a reasonable return for the use of their name, concept and system. Fee setting requires
a high degree of forethought, and franchises that charge exceedingly low fees warrant your
suspicion. Many companies have used low royalties as a big selling tool, only to fail because
they did not have enough income from royalties to sustain their operation when they could no
longer sell franchises for one reason or another.
Insurance
Establishes amounts necessary to protect against worker’s compensation, general and product
liability, bodily injury, and property damage. If you or an employee experience a liability injury
and are not adequately insured, it is possible that the injured person will look to the franchisor
to satisfy a financial claim. Expect franchisors to make adequate provisions for insurance in the
agreement.
Agreement term
The term of the franchise grant is finite, and should be specified in the agreement. Do you want
a long-term or short-term agreement? You should look for a term, and renewal or termination
conditions. You will want to co-ordinate this term with the period of the lease, so that both the
agreement and the lease expire simultaneously.
This way, if you only have a short time between the expiry of the franchise and the expiry of the lease,
you can decide whether or not to renew before renewing the lease. This will minimise the period of time
you will need to pay rent on non-productive premises.
A long-term agreement ensures that the franchisor receives a royalty for a longer period and gives more
security to the franchisee. A short-term agreement gives the franchisor the opportunity to adjust the
royalty – upward if they desire, and to eliminate franchisees that are not performing.
All in all, franchise participants on both sides agree that the longer the term the better. Prospective
franchisees prefer to know they’re going to be in business for a long time, and franchisors don’t have to
worry about the franchisees terminating their agreements after short periods of time.
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Covenants
There are usually restrictive covenants in the franchise agreement that place restrictions on the
franchisee’s ability to compete, divert business, or divulge trade secrets. Conflicts of interest or
confidentiality breaches have far reaching consequences for the franchisee, none of which are
good. Franchisors can’t prevent someone from earning money or making a living, but they
certainly don’t want to sell a franchise outlet and train somebody to run the business profitably,
only to have that person open an identical store of their own down the track. Franchisors have
a right to protect their own interests, which is exactly what restrictive covenants achieve.
Defaults
These are usually done in case of bankruptcy or in the event that a franchisee violates the
agreement. Typical defaults include serving an unauthorised product, failing to keep the outlet
clean, or neglecting to pay royalties and fees. The franchisor serves a notice to rectify the
default within a certain period of time. If the deficiency is not corrected within the specified
time, the franchisee will be disenfranchised.
Termination
The rights and duties of all parties upon expiration or termination should be spelled out. First of
all, provisions must be made with regard to what circumstances constitute grounds for
termination (these may be the defaults mentioned previously). On termination the franchisee
must pay all sums owed, cease using the franchise name, and give the franchisor the right to
purchase all physical assets. All these points should be very clear in the Franchise Agreement.
Consequences of termination
Provisions must be made for identifying grounds for termination, as well as identifying all
parties’ rights in the event that it does happen. A common scenario is that termination allows
the franchisor to reclaim premises, property and rights that are legally theirs. The franchisee
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tends to not have many rights in the event of cessation, so it is a good idea to ensure you fully
understand the consequences.
Transferability
The agreement determines under what conditions the franchisee is able to sell the franchise.
Franchisors usually retain the right to approve any new franchisee since they are going to have
to deal with that person after the current franchisee leaves. The franchisee must, of course,
pay all fees and sums owed, and new franchisees must also be trained.
Succession
The agreement should define the term franchisee to include successors as well as the initial
franchisee. It should contain provisions allowing survivors to apply to continue or sell the
franchise upon the death of the franchisee. The franchisor should have the right to operate the
business in the event of the franchisee’s disability or death.
Special note
As is typical with contracts of this kind, there should be a clause stating that the Franchise
Agreement is the entire agreement, that it over-rides any previous agreements, and that it
provides for amendments, changes or variances only if they are in writing.
Franchise trends
The burgeoning franchise industry in Australia was on a roller coaster ride throughout most of the
1990s. Steady growth was constantly buffeted by negative headlines.
Franchisees across the country complained about franchisors who failed to deliver on their contracts
and attempted bullyboy tactics. They included automotive, men's clothing and food franchises. Many
ended up as painful, expensive court battles.
And there were constant calls for the introduction of a Code of Conduct that would protect franchisees.
In 1998 the industry got its Code of Conduct and today, four years later, the impact on the industry has
been quite significant.
The number of complaints by franchisees against their franchisors has dropped to virtually zero. There's
been a shakeout at the bottom end of the market, and a new breed of franchisees are seeking and
taking up an ever increasing range of franchise opportunities.
The industry currently employs more than 650,000 people in almost 50,000 franchise outlets, licensed
by some 750 franchise systems across Australia.
It turns over around $81 billion a year and significantly, only about one percent of franchisees leave their
businesses each year.
One of Australia's most successful franchisors, Noel Carroll, who built the Michel's Patisserie franchise
with business partner Noel Roberts, remembers the bad old days. "We started out 13 years ago and it
was like the wild, wild, west and yes it was pretty wild and the difference now is we have legislation in
place. It's kept a lot of what we call the backyarders out of the system."
The Code of Conduct, underpinned by the Trade Practices Act and administered by the ACCC, has
upped the ante for both sides of the franchising coin.
Kate Groom, General Manager of Signwave: "I think the code is tough, rightly tough, for the benefit of
prospective franchisees. From our point of view, one of the aspects of the code that was a challenge,
means we have to sometimes explain things in a more user friendly way, than it might be shown to be in
the code."
The code and other legislation, including Occupational Health and Safety and the Privacy Act, also
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demands increased compliance requirements, which means additional costs.
Noel Carroll, Michel's Patisserie: "You've hit a nerve here with me. There's just been a barrage of them,
we don't know what's next. Now don't get me wrong on it, I believe they're good. I believe many are
there to protect the consumer. The problem is they get put to us, without giving us a chance to, without
considering the impost financially and administratively."
"I would have to say it costs us two people at our head office administration, that's for our total chain.
But outside legal costs and accountancy costs and so on, they would have to be well over $100,000
extra," says Carroll.
But it has meant far better and more transparent disclosure, and flow of advice, to potential and existing
franchisees.
Kate Groom: "The code has meant franchisors have to pay attention to informing their franchisees in a
consistent and worthwhile way. I think that has helped franchisees to understand what they are buying
and what they are looking at and focussed franchisors on being professional and respecting the start of
the relationship with a franchisee in a professional way."
And it has helped attract a different level of potential franchisee.
John O'Brien, from Poolwerx: "It has changed dramatically from 10 to 15 years ago. These exhibitions
used to be full of mums and dads and kids with lollies and balloons and it was like a party atmosphere.
But they were really people buying a job. Today the halls are filled with perhaps slightly younger people,
perhaps more educated with more business experience, with more savings, who are making far more
informed business decisions."
"They're well read, well researched, they've got good advisers, solicitors, accountants and they've done
their homework. What that means though is you as an organisation need to prep your staff and be on
your toes and have your t's crossed and your i's dotted."
However, while franchising enjoys a success rate 2.5 times greater than stand-alone small businesses,
there are still some false presumptions among potential franchisees.
Kate Groom agrees there's one common notion: "That it's easy running a small business in a franchise
because the franchisor will provide a solution. A good franchisor will provide a good brand and excellent
systems and exceptional training. But at the end of the day, the franchise owner has to run and operate
the business successfully and profitably and it's their responsibility to do that."
Brendan Greene, Managing Director of Hire-A-Hubby: "Your chances are certainly enhanced there's no
doubt about it, we've got a proven system of methodology that is a successful business model. But it
requires input from the franchisee. It's not a case of buy a franchise rub your hands together and go
cool, now these guys are going to look after me."
Noel Carroll says getting objective, independent opinions about a franchise is the best form of research
before committing to buy: "We always say to people when they come to us 'don't listen to us'. Convince
yourself by other people, talk to franchisees, talk to marketing managers of shopping centres, talk to
landlords, to other people in the industry, talk to other franchise systems and come to us when you've
talked to everybody."
Kate Groom: "If you want to get the outcomes you came into the business for, there is a lot of hard
work. It will be a lot harder in many cases than the job you left, this will be the hardest thing you've ever
done."
But while the franchising industry enjoys a much steadier growth period, it also faces some substantial
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reshaping in the next few years.
John O'Brien: "There will be bigger franchisors, who have perhaps amalgamated with other similar type
franchise organisations. There will be similar franchise banner groups that might join a number of similar
franchises under the one roof. Australian systems will have gone international more, so they will be
more profitable, be able to pass a lot more onto their franchisees in terms of support structures and
marketing."
The Franchise Council of Australia
Website: www.franchise.org.au
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