Table of Contents
- 1. Talk to the Network
- 2. Read the Key Documents
- 3. Analyse the Growth of the Franchise Network
- 4. Look at the Financial Statements and Request Financial Data
- 5. Get Advice
- 6. Get Online and Research
- 7. Be A Mystery Shopper
- 8. Consider Market Trends
- 9. Prepare a Business Plan and Cash-Flow Analysis
- Key Takeaways
- Frequently Asked Questions
Entering into a franchise relationship is a big deal for both parties. Therefore, it is crucial to undertake due diligence before committing to the franchise agreement, which could range from five to ten years. Furthermore, franchisees tend to have more significant risks than the franchisor so due diligence can help them make the most well-informed decision when joining a franchise.
This article will outline what due diligence is and what any prospective franchisee should look to complete to understand better the company or person they are entering into a long-term business relationship.
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1. Talk to the Network
One way to undertake due diligence, is to scope out the success of the franchise business and the level of support the franchisor provides is to speak to the people in business with them. The Franchising Code of Conduct (the Code) prescribes that the disclosure document lists the contact details of existing franchisees. As a bare minimum, try and talk to at least three existing franchises, some of who have been in operation for a while. It may be beneficial to approach the discussion with a set list of questions.
However, avoid limiting your inquiries to only existing franchisees. The disclosure document should also include contact information for former franchisees who have left the network. Make sure to speak to these former franchisees and ask them about their experiences as a franchisee. For instance, you might ask about the following:
- their relationship with the franchisor;
- find out why they left the network;
- whether they got what they wanted out of their time as a franchisee; and
- any advice for someone considering joining the franchise network.
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2. Read the Key Documents
As a franchisee, the Franchising Code of Conduct mandates that franchisors must provide you with many key documents at least 14 days before you sign the franchise agreement. Whilst you should read all these documents personally, they can be very lengthy and full of legal terminology, which can be confusing. To avoid this, start by reading the information statement and the fundamental fact sheet.
Having read these documents, you will have a better idea of what to look out for when reading the franchise agreement and full disclosure document.
Continue reading this article below the form3. Analyse the Growth of the Franchise Network
Here, the disclosure document will provide some insight into the number of franchisees year to year, and the franchisor should be able to supply more historical data. For example, a franchise network showing steady growth is a good sign, but it also looks for terminations. A high termination rate indicates that while the franchise can get people in, the business may not be sustainable.
4. Look at the Financial Statements and Request Financial Data
In particular, it is essential to determine whether the franchise has sufficient financial backing to operate on an ongoing basis. A franchise running on the smell of an oily rag poses a threat of insolvency, which would, in most circumstances, leave your business in the lurch.
5. Get Advice
Obtaining specialist legal, business and accounting advice will allow you to understand your precise legal obligations and any risks or imbalance of power evident from the documentation governing the franchise relationship. Even after the franchise relationship has concluded, a franchise lawyer can identify any:
- indemnities;
- security offered; and
- ongoing risks.
6. Get Online and Research
The internet provides a vast range of review websites whereby anybody can provide feedback on a service or product. It may be helpful to read and see what the public is saying about your prospective franchise.
7. Be A Mystery Shopper
It sounds so simple, but the best way to understand the franchise business is to experience it first-hand. Thinking of becoming a Subway franchisee? Go into Subway. Order a sandwich. Look at the systems. Taste the finished product. And then ask yourself, ‘is this a brand I believe in?’.
8. Consider Market Trends
If you bought into a Cronut franchise, chances are your turnover is not as high as a few years ago, when cronuts were a popular dessert for the in-the-know crowd. Consider market trends and whether this business is sustainable or merely a fad.
9. Prepare a Business Plan and Cash-Flow Analysis
Here, the disclosure document will be invaluable. Look at the franchise fees and expenses you must pay, both upfront and ongoing, and ensure this still leaves a nice cut for you. A great deal of planning and forecasting software is available, and your accountant should be able to assist with this analysis too.
Key Takeaways
It is crucial for any franchisee looking to enter a franchise, to undertake due diligence. Without doing so, you may be left unaware of the critical risks facing you as a franchisee, the franchise’s current financial position and whether or not joining the franchise network is the right move for you. Some key steps you can take are to:
- talk to past and present franchisees;
- read the key documents, starting with the information statement and the key facts sheet;
- get independent legal and business advice; and
- do your own research into the business and overall industry trends.
If you are a prospective franchisee and have any questions about undertaking your due diligence, our experienced franchise lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
As someone looking to join a franchise, you must get advice from other franchisees within the network, both past and present. Thankfully, the Franchising Code of Conduct prescribes that the disclosure document provided to you list the contact details of existing and former franchisees.
The Key Fact Sheet is one of the mandatory documents franchisors need to provide franchisees before they can sign the franchise agreement. It is effectively a snapshot that provides a high-level summary of the key information in the disclosure document.
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