- Potential franchisees should conduct due diligence before buying a franchise, including reviewing the franchise agreement and the disclosure document.
- A prospective franchisee should read the Franchising Code of Conduct prior to buying a franchise. If purchasing a franchise from an existing franchisee, a sale of business agreement is also required.
- There are a number of legal, compliance and contractual issues to consider when buying a franchise. These may include obtaining licences and permits, checking existing contacts such as leases and mortgages, and ensuring the franchisor is not involved in any current or potential litigation.
Franchises in Australia
A franchise is a business arrangement established by contract where a franchisor grants a franchisee the right to use a trademark or trade name in connection with the supply of goods and services by the franchisee. The organisation whose brand you will be using is known as the franchisor while the franchisee is the individual or organisation purchasing the rights of that particular franchise.
It is important to know the different types of franchises available to purchase. Each type has varying advantages and disadvantages.
Product Franchising
In product franchising, the franchisee is allowed through a license granted by the franchisor, to sell or make available the franchisor’s trademarked goods within a stipulated geographic area. The franchisor offers limited assistance and imposes only minor control on the operation of the franchisee’s business.
Business Format Franchising
Here, the franchisor provides the franchisee with a license to sell goods or provide services that are identified with the franchisor’s trademark. The franchisor also allows the franchisee to use a detailed business format, operating system, including a marketing plan and strategy.
Franchising Code of Practice
Franchising practices in Australia are regulated by the Franchising Code of Practice (‘the Code’). This is administered through the Australian Competition and Consumer Commission (ACCC). A franchisor must comply with it in drafting any agreement before presenting it to the franchisee. One important clause is the pre-contract disclosure of important information.
Key Issues
- What are the initial and ongoing fees for running the franchise? What are the conditions of the relationship and how are royalties determined? Note that the initial franchise fee and any renewal fee will be regarded as a capital asset and is not deductible.
- The three most important documents in a franchising relationship is the franchise agreement, disclosure document and the operations manual.
- A franchisor usually requires a franchisee to enter into an agreement for a number of years. For example, McDonalds requires a 20-year commitment in Australia.
Disclosure Obligations
Disclosure requires being transparent in the operation of the franchise and advising any potential issues including:
- all material facts relating to the franchise operation;
- copies of all proposed franchise agreements;
- some statements that assist the prospective franchisee in making the decision of purchasing the franchise; and
- financial statements where applicable.
The precise information and documentation to be disclosed is as set out in the Code.
Advantages and Disadvantages of Buying a Franchise
Established franchises come with goodwill and established methods and procedures. Moreover, a franchisee will have access to industry trade secrets and the valuable know-how of the franchisor. Regarding disadvantages, in addition to potential high start-up and ongoing costs, there can occasionally be high administrative costs passed on from franchisors. Moreover, there is a risk of the overall brand being damaged by another franchisee.
Buying an Existing Franchise
If you are purchasing an existing franchise, there are additional considerations to factor in before purchase. These include:
- Method of Purchase
- Status of Seller
- Ownership
- Real Estate
- Leases
- Machinery and Vehicles
Frequently Asked Questions about Buying a Franchise
Q: What is the difference between a franchise agreement and a distribution agreement?
A: The ongoing royalty payments by the franchisee and some level of control exerted by the franchisor over the business distinguishes it from a general distribution agreement.
Q: Do I need a franchise license to run a franchise?
A: There is no specific licence required to become a franchisee. However, some franchise systems may perform tasks or duties, which in themselves require special licences or permits. For example, selling alcohol requires a Liquor Licence.
Q: What costs should I expect in running a franchise?
A: There are initial and ongoing fees in buying a franchise, and these will be set out in the disclosure document. Ongoing fees can include monthly service and royalty fees, monthly rental, advertising contribution and outgoings such as rates and utilities. Initial costs can include licence fees, stamp duty, documentation fee, training and equipment.
How can LegalVision help me?
LegalVision provides businesses and individuals with tailored online legal advice, including all aspects of franchising purchasing and selling. We can advise on present and future risks, negotiate favourable contractual terms and evaluate the best business structure for your franchise. Call LegalVision today on 1300 544 755.
