Reading time: 19 minutes

The commercial aspects of marketing, reviewing applications and sealing the deal on a franchise sale are complex enough. However, in addition to these challenges, franchise recruiters need to be acutely aware of their legal requirements as well. The Franchising Code of Conduct (the Code) requires strict compliance with a number of processes and procedures in relation to franchise recruitment. Further, it is vital for anyone involved in franchise recruitment to be fully aware of these requirements when undertaking marketing of a franchise opportunity and the recruitment process. This article will explore the franchise recruitment process, covering the: 

  • recruitment timeline; 
  • taking of deposits;
  • operations manual;
  • franchisee training;
  • issuing of franchise documents; and
  • franchise transfers. 

Marketing Material and Correspondence With Prospective Franchisees

The one key legal issue that frequently arises in relation to initial marketing material and subsequent correspondence relates to financial performance, forecasts and budgets. Almost all prospective franchisees will at some point ask how much they can expect to make from the franchise. The franchisor faces a difficult choice when responding to this request. There are a few scenarios that the franchisor could follow:

Scenario 1: Franchisor Does Not Provide Historical Figures or Projections

The franchisor can say (truthfully) it is impossible to project future sales or earnings from a particular location or territory. Instead, they can say the franchisee must make their own projections and budgets as they see fit. Essentially in this scenario, the franchisor provides no historical, present or future financial figures at all. The obvious downside is that this response may result in fewer franchise sales. This is because the franchisee is reluctant to face uncertainty prior to this significant investment.

The upside is that this is the preferred legal position. Any historical performance figures or future financial estimates are fraught with legal risks. The risk is that a franchisee could argue if these figures are not reached that the franchisor engaged in misleading and deceptive conduct.

Scenario 2: Franchisor to Provide Historical Figures

The franchisor may opt to provide some historical figures but decline to provide any projections or budget estimates.  These figures may be based on historical network averages. For some networks, this can be further broken down by state or by the size of store or of the territory. This may involve broad sales averages or may involve more detailed disclosure like expense ratios such as: 

  • percentage rent;
  • percentage gross margin; and
  • percentage labour costs.  

The warning when engaging in this option is that the historical information, even if perfectly accurate, should be reasonably representative for this prospective franchisee. We have seen cases where historical figures were given which purported to be ‘representative’. However, in fact, the figures came from the best performing franchisee in the whole network. This is clearly not advisable. If discovered, this will likely result in significant legal risk of a claim, should similar figures not be reached by this prospective franchisee. The second downside is that if these figures are accurate and representative, they may not be attractive enough to recruit some franchisees to the network. 

There is an upside to providing truly representative and accurate historical figures. It can provide substantial reassurance to the prospective franchisee that the investment is likely to result in reasonable returns. Additionally, it can permit the franchisee to develop its own budget estimates based on actual historical figures.

Tip: Any historical figures that are provided must be accurate and fairly representative for this franchisee. By accurate, we mean that the figures should be reasonably current (not from 5 or 10 years ago). Further, issues such as whether GST is included in sales figures or not should be made explicit to avoid misunderstanding or confusion on the part of the prospective franchisee.  

Scenario 2 Continued: ‘Fairly Representative’ and Use of Waivers

Similarly, if corporate stores are not representative (either because the sales figures are not representative for this franchisee or because franchise fees and other costs are not included in corporate costs), these should be removed from the averages or explicitly separated out. By ‘fairly representative’, we mean that the historical figures should come from locations or stores that are of similar size with similar staff and other costs to the one being sold in this case. Suppose it is known that the historical figures relate to stores or locations different to the one being sold. Then clearly, the analysis needs to be revised to ensure only truly representative stores are included.

Additionally, you should include clear disclaimers when providing the historical information. This will ensure it is clear if any figures supplied:

  • may not be truly representative; or
  • relate to different circumstances to those the current prospective franchisee may experience. 

Moreover, please be aware that disclaimers are not treated as complete waivers of liability by the courts. Suppose a franchisor has supplied clearly misleading historical figures and added a disclaimer ‘not to rely’ on these figures. In that case, the court is unlikely to treat the disclaimer as a complete bar to a claim of misleading and deceptive conduct.  

It is a mistake to be casual in providing inaccurate historical figures merely due to the fact that it is accompanied by a strong disclaimer in bold stating that the prospective franchisee should not rely on the figures but must conduct its own investigation. Such boilerplate disclaimers hold little weight if the court finds the figures were:

  • clearly misleading; and
  • relied upon by the franchisee when signing up to the franchise.

Scenario 3: Permit the Franchisee to Generate Budget and Projections

The franchisor could permit the franchisee to generate its own budget and projections and have the franchisee submit these projections for review and evaluation. The upside to this option is that the franchisor can still maintain it did not provide projections to the franchisee. Although, they can gain an understanding of the level of sophistication of the prospective franchisee’s financial planning and commitment.

The downside is that if the franchisee’s projections are ‘off’ (in the franchisor’s view) the franchisor has an immediate dilemma. They can tell the franchisee the projections are wrong and revise them. This risks them being held responsible for the revised projection as an implied representation made by the franchisor. Or, they can say nothing and by saying nothing, potentially be held to have validated the faulty projection. Again, even with a clear disclaimer stating that in receiving the budget figures, the franchisor is not confirming the accuracy or otherwise of the projections, this does not absolve the franchisor of responsibility to review the figures supplied.  

For example, suppose the prospective franchisee submitted a budget with $5 million in annual sales in the first year. However, the franchisor considers that a figure of $400,000 is a more accurate estimate. In that case, saying nothing when the budget is submitted for approval could be considered an endorsement of the clearly unrealistic sales figure.  

Scenario 3 Continued: Only for Sophistocated Franchisors

We have seen franchisors take up this option to good effect, but only in circumstances where the franchisor is very professional in the review and handling of the projections. Additionally, they must provide clear communication that cannot be misconstrued as an endorsement of unrealistic projections. Those who successfully use this option either: 

  • make it clear they will not comment on the budget itself. Rather, they are simply seeking the receipt of the budget, and this should not be taken as endorsement; or
  • if feedback is in fact given, often take a critical view of the budget supplied. They may suggest sales projections be revised downwards or costs increased to deal with unexpected contingencies.

Tip: Sophisticated franchisors should only undertake this option as they have extensive experience, which allows them to see whether a particular budget is within realistic boundaries or not. For startup franchisors, this option is not recommended.

Scenario 4: Franchisor to Provide Projections

The franchisor could provide projections. This could take the form of a:

  • hypothetical ‘average store’; or
  • specifically developed budget for this store or territory in particular.

Regardless, this approach is fraught with legal risk and is strongly discouraged. First, the Code requires all financial projections to be made on ‘reasonable grounds’. In addition, the Code requires that when a franchisor supplies future projections, they also provide:

  • any facts or assumptions on which the forecast is based;
  • details of the research undertaken and the extent of any enquiries made to support the forecast;
  • whether the forecast includes any costs or write-offs, such as depreciation of assets, salary or wages for the franchisee. Or, the cost of meeting any loans on the business (for example, interest and repayments); and
  • any assumptions built into the estimate regarding tax obligations.

Finally, in the disclosure document itself (which must be supplied at least 14 days prior to the signing of franchise documentation), there is a section that asks whether financial projections have been given. This must be ticked ‘yes’  if any financial projections are supplied.  

It goes without saying that these requirements are demanding. Therefore, supplying projections is creates serious legal risk. It may be tempting to provide projections to bolster the prospective franchisee’s ability to obtain finance and reassure the prospective franchisee of the growth potential of the opportunity. However, this practice over the long term results inevitably in legal claims when a franchisee does not achieve the figures contemplated under the projection. This commonly occurs regardless of the warnings and disclaimers plastered over the document. Therefore, the strong recommendation is not to provide financial projections to any prospective franchisee – ever. 

Recruitment Timeline 

The key legal requirement to keep in mind during franchisee recruitment is a simple one: issue franchise documentation at least 14 days prior to: 

  • the franchise agreement being signed; or
  • accepting non-refundable money paid towards the franchise.

The franchise documentation ‘package’ will consist of the: 

  • disclosure document; 
  • franchise agreement; 
  • franchising code; 
  • information statement; and 
  • key facts sheet.  

Tip: Aside from this fundamental legal point, a number of issues can arise during the franchise recruitment process. Therefore, it is important to outline the usual franchise recruitment timeline and point out some key points at each stage:

1. Expression of Interest and Confidentiality Agreement

Normally, a prospective franchisee expresses some interest via an expression of interest form or some other means of confirming their interest in responding to your marketing material. At this point, it is important to obtain basic information to qualify the prospective franchisee to determine whether they are appropriate to take the next step. If so, then you should ensure they sign an appropriate confidentiality agreement.

2. Initial Meeting and Application Form

An initial meeting takes place where some basic information is provided regarding the franchise, including: 

  • estimated costs; and
  • some of the requirements of the franchise.  

This often is contained in a franchise information brochure or similar document. At this initial meeting, an application form may be provided, which the prospective franchisee will then need to complete outlining: 

  • their asset position;
  • their previous experience; and
  • other relevant information relating to their suitability as franchisees.

3. Preliminary Budget and Business Plan Submitted and Template Documents Provided to Franchisee

The prospective franchisee may develop a preliminary budget and business plan to submit to a bank to obtain finance to purchase the franchise. Additionally, they may speak to their accountant or lawyer to set up an appropriate structure to purchase the franchise (often involving setting up a company and family trust). 

At this point, you may wish to provide the prospective franchisee with template documents such as the template disclosure document and key facts sheet and franchise agreement. This is so they can understand the anticipated start up and operating costs in more detail. 

Note that if these documents are issued just as ‘blank’ templates (with the franchisee’s company details filled in), then this will not start the formal 14-day disclosure period. A second set of ‘customised’ franchise documents will need to be issued for that period to commence once the company details and guarantor details are known.

4. Franchisee Undertakes Preliminary Due Diligence

The franchisee may contact existing franchisees and visit existing franchise locations during this preliminary due diligence period. Franchisees are under no obligation to cooperate or respond. However, it is likely a prospective franchisee will do so. Therefore, you should ensure there is a system in place to address this, such as requiring the prospective franchisee to inform you which franchisees may be contacted. That way, you are aware of who they will contact within the network. 

During this due diligence process, they may ask additional, more detailed questions about the operation.  This is to be expected (and welcomed) as it will show the prospective franchisee has undertaken appropriate preparation for the purchase. At this point, the prospective franchisee will be in the process of setting up the company structure and finalising finance. You may wish to seek a refundable deposit at this point to confirm the seriousness of the prospect’s intentions. 

Please note that at this point, any payment towards the franchisee fee must be fully refundable. However, you can ask for documentation preparation costs to be paid at this point, provided this is a fixed fee and is disclosed in the disclosure document.

5. Final Legal Documentation is Prepared and 14-Day Disclosure Period Commences

Once the company details and guarantor details are known, and the prospective franchisee has confirmed their intention and ability to proceed, the final legal documentation should be prepared and issued. This will commence the formal 14-day disclosure period. The franchisee should be encouraged (or even required) to obtain legal advice. Further, if they seek amendments, these should be considered reasonably. 

Accepting at least some amendments will assist in any subsequent argument that your franchise agreement was not a ‘standard form contract’. Therefore, arguing it should not be subject to the unfair contracts rules that apply to non-negotiable standard form contracts.

6. Franchise Agreement is Signed and Moneys Paid

Once the 14-day disclosure period has ended, the franchise agreement can be signed and non-refundable monies paid.  

7. 14-Day Cooling-Off Period

In addition, there is a 14-day cooling-off period, even after the signing of the franchise agreement.  However, reasonable fees can be deducted (such as training and administration fees) should this termination take place.

8. Leasing

If there are premises involved and the franchisor is proposing to take the head lease, clearly there is an added complexity. When should the lease be signed, and when should be sub-lease (or licence to occupy) to the franchisee be issued? It is strongly advised that the franchise agreement be signed (and paid for) before the commitment to a lease is made. This ensures that you do not expose yourself to a franchisee ‘backing away’ at the last minute and leaving you with a substantial leasing obligation without a franchisee to operate the location.

Tip: If you have to miss out on a location due to delays in finalising a franchise, so be it. It is far preferable to miss a location than to commit to a location before the franchisee is fully committed to the site.

Taking Deposits 

As indicated in the timeline above, the taking of a deposit is an important step in the franchise recruitment process. However, a surprising number of franchisors do not understand the process.

Any amount paid towards the franchise fee before the formal documentation is signed should be fully refundable if the prospective franchisee does not proceed. For example, suppose the franchisee has paid a ‘holding deposit’ of $5000. Even if you have spent weeks negotiating with that prospect, if they pull out at the last minute you should return the deposit to them.

However, this does not mean all monies paid prior to signing are fully refundable. Separate payments can be made that are non-refundable, provided:

  • it is made clear to the prospective franchisee that a separate payment is being made for a specific service separate from the deposit on the franchise fee; and
  • this is adequately disclosed in the disclosure document and written correspondence.

For example, you can charge a fixed fee for the preparation and finalisation of legal documents that is to be paid to the franchisor’s lawyers on behalf of the franchisor but payable by the franchisee. In addition, you may charge a fixed fee to arrange visits to head office or specific franchise stores to compensate for the time taken to arrange such meetings.  

The issue is often not the charge itself (although it is obviously recommended that the charges be kept to a reasonable amount). Rather, it is the confusion regarding what the payment is for that causes conflict.  

Tip: You should issue separate invoices and receipts for services that are non-refundable and for the deposit. This will help to avoid the impression that a lump sum amount is all going towards the franchise fee and is therefore fully refundable prior to signing.

Operations Manual

Another issue that can arise relates to the supplying of the operations manual and other confidential information. It is to be expected that prospective franchisees will ask to see as much of the operation as possible to understand how the system works. Also, they may ask to review sensitive and confidential information prior to paying any deposit or signing the franchise documentation.

The obvious question is: how much information should you reveal and when? Regardless of what confidentiality agreement is signed, there is always the risk that a prospective franchisee will take whatever information you provide and walk away from negotiations and set up a competing concept.  

It is therefore vital that you provide information in a staggered, measured way. This will ensure you do not provide any valuable confidential information to someone who is not committed to progressing to become a franchisee.

You should not reveal your list of approved suppliers until the prospect is signed up as a franchisee. The operations manual may have to be provided for a prospect to proceed. However, at the very least you should do this after a holding deposit has been paid. Further, you should provide the manual in circumstances which ensure: 

  • copies cannot be made; and
  • the prospect cannot take away valuable information that could be used to set up a competing concept.  

Tip: A copy could be provided in a specific location (such as a room at head office) for an hour or so. Alternatively, password access could be provided for a limited time to allow online access on the condition that no copies are made of the manual.

Training

In addition, the timing of training may be an issue. Franchisors should not commence training and in-store exposure prior to the formal signing of legal documentation. It is tempting to start the training early, especially in circumstances where you are confident they will proceed. However, there have been circumstances where the training itself (or the in-store visits) have ‘turned off’ the prospect. As a result, they leave just at the time they were due to sign the legal documentation.   

Therefore, training and in-store visits should only take place after the franchisee has formally signed the documentation is formally signed and has paid the full franchise fee. Do not be tempted to speed up the process.

Issuing (particularised) Franchise Documents and Waiting the 14-Day Disclosure Period

As discussed above, the 14-day disclosure period only commences once the: 

  • specific details of the franchisee is provided;
  • company and guarantor details are confirmed; and 
  • legal documentation is drafted and issued.

Franchise Transfers

The process of signing up a new franchisee who has purchased the business from an existing franchisee is similar. However, you should note some additional cautions.

First, the vendor is responsible for providing sales and financial information. It may be the case that the purchaser seeks confirmation from you as the franchisor of certain financial data provided by the vendor franchisee. You should resist the temptation to provide financial information for several reasons. Such information is confidential, and releasing it would require the consent of the vendor franchisee. In addition, getting involved in providing financial information could make you complicit in any misrepresentation that would otherwise have been a matter for the vendor alone to address.

The recommended approach is simply to: 

  • refer the purchaser to the vendor; and 
  • state in clear terms that the franchisor does not get involved in the sale process as this is a matter for the vendor franchisee.

Second, the selling franchisee is often very keen to leave and presses to have the purchasing franchisee trained up and operating the store or franchise business prior to signing the formal legal documentation. Again, as discussed above, you should insist that the outgoing franchisee continues to be present and operate the franchise until the date of completion and until the purchaser has purchased the franchise.

Training of the new franchisee should take place after the franchise documentation is signed but before the date of completion under the business sale agreement. The reason is that if the incoming franchisee fails the training or otherwise is identified as an unacceptable franchisee, that candidate can be removed without complexity.

Key Takeaways

There are a number of processes and procedures that franchisors need to comply with in relation to franchise recruitment of potential franchisees. Therefore, it is important that you are aware of these requirements when undertaking marketing of a franchise opportunity and the recruitment process. Doing so will help to avoid any potential issues that may arise. It will also ensure that you take on quality franchisees. Finally, it is important to keep in mind that the ACCC occasionally issues directives and notifications on their website in relation to franchise recruitment. Therefore, it is important to keep up to date with the latest news from the ACCC to stay aware of the latest developments. For further information regarding the franchise recruitment process, contact LegalVision’s franchise lawyers on 1300 544 755 or fill out the form on this page.

Frequently Asked Questions

What does the franchise document ‘package’ consist of?

The disclosure document, franchise agreement, franchising code, information statement and key facts sheet.  

When should franchisors commence training?

Franchisors should not commence training and in-store exposure prior to the formal signing of legal documentation and payment of the full franchise fee.

Webinars

Australia’s Global Talent Visa: How to Attract Top Talent

Thursday 7 October | 11:00 - 11:45am

Online
Understand how to navigate Australia’s complex migration system to attract top overseas talent with our free webinar.
Register Now

5 Essential Contracts for your Online Business

Thursday 14 October | 11:00 - 11:45am

Online
Learn which key contracts will best protect your online business with our free webinar.
Register Now

Key Considerations When Buying a Business

Thursday 11 November | 11:00 - 11:45am

Online
Learn which questions to ask when buying a business to avoid legal and operational pitfalls, so you can hit the ground running. Join our free webinar.
Register Now

About LegalVision: LegalVision is a tech-driven, full-service commercial law firm that uses technology to deliver a faster, better quality and more cost-effective client experience.

The majority of our clients are LVConnect members. By becoming a member, you can stay ahead of legal issues while staying on top of costs. From just $119 per week, get all your contracts sorted, trade marks registered and questions answered by experienced business lawyers.

Learn more about LVConnect

Need Legal Help? Get a Free Fixed-Fee Quote

If you would like to receive a free fixed-fee quote or get in touch with our team, fill out the form below.

Our Awards

  • 2020 Excellence in Technology & Innovation Finalist – Australasian Law Awards
  • 2020 Employer of Choice Winner – Australasian Lawyer
  • 2021 Fastest Growing Law Firm - Financial Times APAC 500
  • 2020 AFR Fast 100 List - Australian Financial Review
  • 2021 Law Firm of the Year - Australasian Law Awards
  • 2019 Most Innovative Firm - Australasian Lawyer