Buying into an established brand is one of the reasons many people consider becoming franchisees. However, entering into a franchise agreement is a significant undertaking. Before you do, you need to think about all the relevant legal considerations. This article outlines what you need to know about franchise agreements and what you should do before buying a franchise.
A franchise is a business arrangement that allows a business entity – sole trader, partnership or company – to use the trade mark or trade name of an existing business to supply goods and services. People typically refer to a ‘franchise’ in general terms, but there are different kinds of franchises, including a business format franchise, product franchise or manufacturing franchise.
A franchise agreement is the formal legal document that creates each new franchise relationship. Franchise agreements are complex, usually lengthy and set out the obligations that a franchisee owes a franchisor and vice versa. These obligations can be commercial as well as non-commercial.
A franchisee will have obligations regarding:
- Performance Criteria;
- Payment of Fees;
- The supply of products and services; and
The fees a franchisee is liable to pay could include the upfront amount for the use of the franchisor’s name, operating systems, intellectual property and know-how. They will also likely include the payment of ongoing fees or royalties for the franchisor’s continued business, management and technical support. The agreement might express these ongoing payments as a percentage of turnover. The agreement might also include transfer fees and termination fees.
Similarly, under the Franchise Agreement a franchisor has obligations that include:
- Approved equipment;
- Approved suppliers;
- Approved products;
- Advertising and marketing;
- Assistance and support; and
- Client enquiries.
Franchising Code of Conduct
All franchise agreements must comply with the Franchising Code of Conduct (the Code). The Code is a mandatory industry code that applies to all parties to a franchise agreement. The Australian Competition and Consumer Commission (ACCC) regulates and enforces compliance with the Code. The Code is intended to ensure that all prospective franchisees are adequately informed before they enter into a franchise agreement and requires all parties to an agreement to act in good faith.
The Code requires that before entering into a franchise agreement a franchisor must provide a prospective franchisee, as well as existing franchisees, with a disclosure document. The disclosure document outlines information on the business and includes its expected annual turnover. A franchisor must update this document within four months of the end of the financial year.
Buying a Franchise
Before a prospective franchisee enters into any franchise agreement, there are some things they can do to ensure they are as informed as possible about the business. The most important of these is to speak with a franchise lawyer. Franchise lawyers can help franchisees understand their rights and obligations under the agreement. An agreement might heavily favour a franchisor, so it is essential that a prospective franchisee has an independent party read the contract before they commit to it.
Be aware that the success or failure of a franchise owes much to location and the experience of the particular franchisee. Do as much due diligence as you can to find out about the business yourself, and don’t blindly trust everything the franchisor tells you. You will also need to find out if you require any specific licences or qualifications to operate the business. You should also think about the best business structure for your needs. Different business structures have different implications, including for taxation, and every franchisee needs a structure that is right for them. A legal professional can provide advice on this issue.
Becoming a franchisee is a significant undertaking. Before a person enters into a franchise agreement, they must understand all the legal documentation relating to the franchise. These documents include the franchise agreement together with any annexures, the disclosure document and the franchisors manual. They should also be familiar with the Franchising Code of Conduct. LegalVision’s Franchise Lawyers can assist you with the process of setting up or selling a franchise, from start to finish. Call us on 1300 544 755 today.