As a franchisee, a franchisor allows you to use their intellectual property, business systems, and sometimes an existing client or customer base in your own business. Some franchise systems require their franchisees to operate via corporate vehicles. Indeed, there are several key structures to consider when purchasing an existing franchise or establishing a new one. This article considers the advantages and disadvantages of each franchise business structure.
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Single Company
Setting up a proprietary limited company to operate a franchise will protect your personal assets, as a company is a separate legal entity. It is capable of owning its assets and liabilities and entering into contracts on behalf of the franchise. One of the primary advantages of this structure is the limited liability it offers. As a shareholder, your personal assets are generally protected if the company faces financial difficulties or legal issues. This means that your personal assets are safeguarded from business creditors, subject to certain exceptions such as personal guarantees. However, this advantage is consistent across all company structures.
There are some potential disadvantages of having a single company operate a business. If your company falls into financial difficulties, generally, all of the business’s valuable assets and intellectual property are at risk. If you needed to wind up the company, you could potentially lose all of the business’ assets. Further establishing and maintaining a company involves more paperwork and higher costs compared to simpler structures like sole traderships.
Two-Tiered Company
Some businesses opt to establish a two-tiered company structure to safeguard their valuable assets. You can do this through a holding company and operating company relationship. In this case, the holding company owns the assets and intellectual property of the business, while the subsidiary company serves as the operating entity. This means that the subsidiary company is the entity that enters into contracts and incurs liabilities. It does not own any assets of the business.
The main disadvantages of this structure are that it is expensive to set up and manage. This is because you must have separate accounts and records for each company. You will also need legal agreements in place between the companies for the licensing of any intellectual property.
In the Context of Franchising
In the context of franchise agreements, franchisors typically require a single entity to act as the franchisee. This simplifies the contractual relationship and streamlines accountability. However, franchisors are often aware that franchisees may operate through more complex business structures. As such, any entities related to the primary franchisee entity are usually asked to play one of two roles:
- Guarantor: These related entities may be required to guarantee the performance of the primary franchisee.
- Joint and Several Franchisee: Alternatively, related entities might be added to the franchise agreement as joint and several franchisees.
Further, in a typical franchise relationship, the franchisor retains ownership of the business’s most valuable assets, particularly the intellectual property. Given this arrangement, operating a franchise through a two-tiered company structure may often be unnecessary. The franchisor’s ownership of key assets already provides a level of protection for these valuable components of the business. Therefore, the added complexity and cost of maintaining a two-tiered structure might not offer significant additional benefits for many franchisees.
Continue reading this article below the formFranchise Trust Structure
The final business structure to consider for operating your franchise is a trust. There are two different types of trusts:
- discretionary (family); or
- unit trusts.
With either trust type, there is a trustee that owns the business’s assets and operates the business on behalf of the trust.
A discretionary trust allows the trustee to choose how to distribute the assets to the trust’s beneficiaries. A unit trust differs because the trustee does not have a choice in how it distributes the assets. Instead, the beneficiaries of a unit trust own a set number of units and receive a corresponding share of the distribution based on this ownership.
Moreover, with a trust, the trustee is the legal entity, not the trust itself. Indeed, a trustee can be an individual or a company. The advantages of a trust include tax and asset protection benefits. It would be helpful to discuss this with an accountant to determine how it would impact your specific circumstances.
The disadvantage of a trust is that it is more expensive to set up than a company. This is particularly true if you also wish to establish a corporate trustee. The trust must distribute the profit or income of the trust to the beneficiaries each financial year to avoid paying the highest tax rate. If your business needs working capital or wants to attract investment, this can be a problem.
In the Context of Franchising
When entering into a franchise agreement, you may often be required to provide a trust deed to the franchisor. A trust deed is a legal document that outlines the terms and conditions under which a trust is established and operated. It defines the trust’s purpose, identifies the trustee and beneficiaries, and specifies how the trust’s assets should be managed and distributed.
The trust will also be explicitly referenced in the franchise agreement. This agreement will typically include specific clauses relating to trusts, where you, as the franchisee, will need to provide specific warranties regarding the operation and powers of the trust.
Whether or not a trust structure will work for your franchise will depend on:
- what your business plans are;
- how much working capital the franchise requires to operate; and
- how long you want to be in the franchise.
Sole Trader
Operating a franchise as a sole trader is one of the simplest and most cost-effective structures available. As a sole trader, you run the franchise as an individual, and you’re required to register for an Australian Business Number (ABN) for tax purposes. It’s important to note that while you’ll be using the franchisor’s trading name, your ABN will be distinct from the franchisor’s.
In the Context of Franchising
In a franchise context, sole traders can benefit from certain tax deductions specific to franchising. These may include franchise fees, royalty payments, marketing contributions, and costs associated with franchisor-mandated training or equipment. However, the major drawback of this structure in franchising is personal liability. As a sole trader, you’re personally responsible for all aspects of the franchise, including debts and legal obligations. This means your personal assets could be at risk if the franchise encounters financial difficulties or legal issues.
Partnerships
A partnership structure for a franchise involves two or more individuals jointly operating the franchise. Like sole traders, partnerships require an ABN registration. In a franchise context, partnerships can be advantageous as they allow for shared responsibilities, combined resources, and diverse skill sets, which can be beneficial in managing the various aspects of a franchise operation.
When establishing a franchise partnership, it is crucial to draft a comprehensive partnership agreement. This legal document should clearly outline:
- Each partner’s roles and responsibilities in operating the franchise
- The capital contribution of each partner
- How profits and losses will be shared
- Decision-making processes, especially for major decisions affecting the franchise
- Procedures for resolving disputes
- Exit strategies, including what happens if a partner wants to leave or if the partnership dissolves
Partners can claim similar franchise-specific deductions as sole traders, including royalties, marketing fees, and training costs. The partnership structure also allows for flexible profit-sharing arrangements, which can be attractive when different partners contribute varying levels of capital or effort to the franchise.
However, partnerships, like sole traderships, don’t provide asset protection in a franchising context. Each partner is jointly and severally liable for the franchise’s debts and obligations. This means that if one partner can’t pay, the other partners are responsible for the full amount. This level of risk can be particularly concerning in a franchise setting, where substantial ongoing financial commitments to the franchisor are typical.
Moreover, some franchisors may have reservations about partnership structures due to the potential for disputes between partners, which could affect the franchise’s operations. Many franchise agreements will require all partners to provide personal guarantees and may include provisions for what happens if the partnership dissolves.
Issues to Consider
Now that you are aware of the available structures, you must consider your specific circumstances and other requirements particular to the franchise you wish to purchase.
Despite this, a company structure would still provide personal asset protection in your dealings with third parties, such as customers or suppliers.
If you wish to set up a company to operate your franchise, it is also essential to consider how you will own your shares in that company. For example, you can own your shares individually, through a company, or in a trust. Discussing this with an accountant will help to understand the tax implications of each personal ownership model.
Lastly, think about succession planning. Your chosen structure can affect how easily you can transfer ownership or bring in new partners. This is particularly important if you’re considering a family business or planning for retirement. Some structures offer more flexibility in this regard, which could be a deciding factor depending on your future plans.
Key Takeaways
Choosing the proper business structure for your franchise can be a complex process. You must consider the best option for your business and examine all the relevant circumstances. For instance, popular business structures include:
- single companies;
- two-tiered companies;
- franchise trust structure.
- sole trader; and
- partnership
If you have any questions about selecting the right business structure for your franchise, our experienced franchise lawyers can provide assistance 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
A sole trader refers to a business owned by a person, whereas a partnership involves two or more people conducting a common business enterprise. This requires you to register an ABN (Australian Business Number) for taxation purposes.
Under a unit trust, the trustee has no choice in how to distribute the assets. Instead, the beneficiaries of a unit trust own a set number of units and receive a corresponding share of the distribution based on this ownership.
Yes, it is possible to change your business structure, but it can be complex, may require the approval of the franchisor and may have tax implications. It is best to consult with a lawyer and an accountant before making such a change. Additionally, review your franchise agreement, as most franchisors require approval for any structural changes.
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