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For the new business owner, buying an existing franchise can easily be an attractive and accessible opportunity. Buying an existing franchise allows you to purchase a business with a visible trading history. Additionally, you will also benefit from trading under an established brand name and joining a network of other franchisees. The buyer’s journey for purchasing an existing franchise is quite different from that of a buyer who is buying a new franchise or an independently operated business. For example, concurrent with your discussions with the business owner, you should also expect to be introduced to the franchisor or franchise recruitment manager representing the business brand. This article: 

  • sets out the importance of conducting your due diligence before committing to the business purchase; and 
  • provides examples of a number of information sources, which may assist you with reaching an informed decision. 

What is Due Diligence?

When buying an existing  franchise, you would benefit from conducting due diligence across the following areas:

  • commercial: educate yourself on the brand’s culture, values and mission, and how it is positioned in the market;
  • financial: evaluate the historical sales and trading data of the business, foot traffic, current clients and work in progress; and
  • legal: understand the obligations in the franchise agreement. Consider any leasing arrangements which may apply to you once you take over the business.

Due diligence describes the process of self-driven investigation, helping to provide a complete picture of a business before you commit. At various stages of the process, the existing franchise owner will provide you with increasing detail on the business. 

Commercial Due Diligence

When you express interest in buying an existing franchise, you should evaluate the information given to you by the franchisor relating to the: 

  • performance of the franchise network; and
  • support you can expect to receive from the franchisor.  

At a minimum, you should ask the current franchisee or franchisor for more information regarding:

  • how long the business has been running in that same location;
  • if there are any other franchises in the same suburb;
  • what the boundaries to your territory are (e.g. what suburbs fall within your territory?);
  • whether you have exclusive territory;
  • Whether any  ongoing fees in the franchise or other expected expenses exist; and
  • what sort of changes (if any) has the franchisor made to the ongoing fees in the past?

Financial Due Diligence: Historical Sales and Trading Data

When you are purchasing a ‘greenfield’ franchise, you will need to rely on the franchisor’s general financial disclosure documents. These will assist in making an educated guess on the likelihood of the business being successful and profitable in the particular geographical area you want to purchase. However, there is a key advantage to purchasing an existing franchise, as opposed to a new ‘greenfield’ franchise. It is that the business will undoubtedly keep a record of their historical trading data.

This data will be specific to the location of that franchise and is invaluable when conducting your due diligence. 

A franchisor will generally require a franchisee to track the volume of customers or sales in a structured manner, using a centralised point of sale and accounting system that is approved by the franchisor. The current franchisee may also generally be expected to provide weekly or monthly income reports. These allow the franchisor to calculate the total franchise fees payable. Accordingly, this means that when your discussions with the current franchisee become more serious and progressed, the historical sales and trading data of the business should be readily accessible to you on enquiry.  

You should try to prepare a business plan and cash flow forecast using the information in the disclosure document. You should also enlist professional help from an accountant or accredited business expert in this area. This step will be relevant to the purchase of any existing franchise, whether you are looking to buy a  ‘mobile’ franchise that operates out of a home office or a franchise that operates from a physical location.

Legal Due Diligence 

Risks and Rewards for a Franchisee

As a prospective franchisee, in your earliest dealings with the franchisor, you should be supplied with a fact sheet called an information statement. The information statement is a short fact sheet that sets out some of the standard risks and rewards you should consider before becoming a franchisee.

Prospective franchisees should be aware that the franchise agreement will usually incorporate strict performance standards, setting out how you conduct business. When you buy a franchise, the franchisor grants you the right to run a business using their: 

The success of the franchise brand relies on all franchisees running their businesses consistent with the brand guidelines and the business systems.

There are also free online education courses available for prospective franchisees if you want to understand the business model in more detail.

The Obligation to Act in Good Faith

Wherever possible, when conducting due diligence, you should be aware that your discussions with the franchisor should demonstrate, on their part, a willingness to act in good faith. Franchisors have a duty to act honestly with you from the outset of your discussions with them about joining the franchise network and in the lead up to you making a commitment to buy the existing franchise. This is an expectation imposed on them by the Franchising Code of Conduct. Nevertheless, it is always best to seek and receive information from the franchisor in written form. This is rather than relying on information that is only verbally conveyed to you, as you may wish to refer back to this at a later date. 

Suppose you notice the franchisor, franchise recruitment manager, or their representatives are providing you with conflicting information. In that case, you should consider whether they are acting in good faith with you from the outset. 

Leasing Arrangements

If you are buying a business that operates from a physical location such as a commercial office, retail store, or warehouse, it will be further important to ask questions which help you to understand all the legal obligations you will take on as the new franchisee. 

It is possible that the leasing arrangement for an existing franchise will look quite different to the typical relationship between a landlord and the owner of an independently operated business that is not part of a franchise network. The leasing arrangements for an existing franchise should fall into one of four categories below:

  • the franchisor holds the lease as a tenant;
  • the current owner holds the lease as a tenant;
  • you will hold the lease as a tenant when you take over the business; or
  • you are required to find new commercial premises to lease.

If the franchisor is the tenant of the premises, you will be provided with a sub-lease agreement or licence agreement instead of a lease agreement. Both of these documents mean that your rights to occupy and operate the business from the property will be set out by reference to your agreement with the franchisor and the terms of the document that they provide to you. 

At a minimum, you should speak with the current franchisee to understand:

  • whether they are the tenant holding the lease directly with the landlord; 
  • how far they are into the lease and how much longer is left on the lease;
  • whether the term of the lease matches up with the term of the proposed franchise agreement; and
  • whether the lease needs to be renewed. If so, whether this will affect your ability to continue operating the franchise if relocation is required.

Additional Information Sources

In addition to the considerations discussed above, you can also conduct due diligence by gathering information from the following information sources:

  • other franchisees’ experiences;
  • customer feedback; and
  • personal observations.

Other Franchisees’ Experiences

The promise of ongoing franchisor support is a distinguishing factor that may have led you to explore the opportunity of becoming a franchisee and purchasing an existing franchise. Strong business performance will generally be better maintained if the franchisor is actively and effectively supporting each franchisee within the network. When you are conducting due diligence, you should ask questions about the franchisor’s marketing strategies and ask about any network-wide recent campaigns that they ran. This will help you to understand the type of business support you will receive.

Separately, it is often no less important to contact existing franchisees to gain their honest opinion and experiences as a franchisee within the network. You may want to seek their insight into:

  • whether they were happy with the business model and franchise system; 
  • the level of day to day and ongoing support received from a franchisor; 
  • the level of social media marketing and business promotional initiatives conducted by the franchisor; 
  • any significant changes introduced by the franchisor in recent years and, if any, whether franchisees were suitably notified; 
  • the general management dynamics of the head office; and
  • whether they became aware of any competitors to the franchise.

Customer Feedback

In addition to speaking with existing franchisees, you should also navigate the franchisor’s website and social media pages. You may find that in some franchise networks, a franchisor will manage all social media pages for each existing franchise. However, in other networks, there can be variance between social media pages if the franchisee themselves manage them.

Furthermore, you can conduct due diligence by researching customer reviews on Google to understand the market perception of the franchise network. This will also help discover whether it holds a good reputation with its customers. 

For example, in a retail or hospitality business, you may find it valuable also to consider customer reviews on food delivery apps, such as Deliveroo and Zomato.

Once you have evaluated the pricing and expected market, you will be in a better position to consider the franchise fees and profitability of the business.

Personal Observations

If you are buying an existing franchise, attendance at the premises is the best way to understand the variables which drive how the business is performing. For example, by attending a store at different times of the day, you may gain insight into its busy and quiet periods. Having a better understanding of the above factors allows you to anticipate the associated expenses of paying staff to service customer demand.

If you are buying a new franchise, there will be less information available about the location of the franchise. Nevertheless, at minimum, the franchisor should still be able to help you to understand:

  • how long the franchise system has been in operation;
  • how many franchises currently exist in your city;
  • what the location spread of the existing franchises in your city is;
  • whether you will have exclusive territory; and
  • what the ongoing fees in the franchise are. 

Key Takeaways

It can be very rewarding to run your own business under a well-established brand name and within a franchise system. However, buying a franchise does require you to carefully consider the commercial and legal risks which are unique to the franchise opportunity. The due diligence you conduct should therefore involve speaking with a variety of people to better understand the risks and rewards.

When undertaking due diligence, it is important to research the:

  • commercial viability of purchasing a franchise;
  • historical sales and trading data of the business; 
  • experiences of other franchisees; and
  • general obligations on yourself and the franchisor in the Franchise Code of Conduct.

The final step to conducting your due diligence is to have your franchise agreement and disclosure document reviewed by a franchise lawyer.  For assistance with this, contact LegalVision’s franchise lawyers on 1300 544 755 or fill out the form on this page.

Frequently Asked Questions

What is due diligence?

It is the process of self-driven investigation which helps to provide a complete picture of a business before you commit to anything.

What is the obligation to act in good faith?

Your discussions with the franchisor should demonstrate, on their part, a willingness to act in good faith. This means that franchisors have a duty to act honestly with you from the outset of your discussions with them about joining the franchise network.

What are some types of due diligence?

You can conduct commercial, financial and legal due diligence. You can also conduct due diligence by gathering information from other franchisees’ experiences, customer feedback; and personal observations.

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