EVALUATING A FRANCHISE

Franchising is one of the fastest growing areas in the economy today. It is a fact that most new jobs are being created in the small business area. Franchising is in the forefront of the small business area. It is taking an ever expanding share of this sector. There are over 400 franchises in Australia at present. Macdonald's, Kentucky Fried Chicken (KFC), Pizza Hut, Cut Price Deli, Wendys Supa Sundaes, to name but a few, are household words. Franchising is most prevalent in fast food, restaurants, real estate and convenience stores. However, franchising is constantly expanding into new areas. The franchisee benefits from instant public recognition of a developed business image. Statistics show that 80% of small businesses do not survive for five years. The success rate for franchises is much higher.

Often, the typical buyer of a franchise today is a retrenched middle manager in his 30's or 40's with a fat redundancy cheque. In effect, he is buying himself another job and being trained in it. Also, it is a "job" from which he cannot be fired. The franchise provides a sheltered business environment.

However, the presence of these cash-rich middle managers seeking franchises has attracted "sharks" to the scene. If you study any publication which lists franchises for sale, you will usually find a number of dubious franchise schemes on offer. Often, they demand a large upfront payment. In return, the franchisee is given the right to carry on some ordinary everyday activity under a Business Name. The use of the Business Name adds little or nothing to the potential of the business. Little training is provided. Sometimes even, the seller has a ready-made list of his friends that you can phone. They will provide glowing testimonials. So, beware, and check out any proposed franchise very carefully.

Before you think of buying a franchise, ask yourself Am I the type that will succeed in a franchise? Most self-employed persons work long and hard hours. Often, these days, it can entail night and weekend work. In addition, you must be self- disciplined. You will have no boss to drive you. Are you a good money manager? If you spend every cent you can lay your hands on and never save anything, that can be a warning signal that you will not succeed as a franchisee. For one thing, you will have to accumulate funds to pay your yearly tax bill in one king hit.

Is your health good? You will need good health to stand up to the strain of running a business and the long hours.

What skills have you got? What type of business would you like to work in? The answers to these questions will determine what franchises you want to check out.

You have found a franchise that you are interested in. Now, you make contact with the franchisor by phoning or writing. What information should you obtain?

The first information you should obtain is whether the franchisor abides by the Franchising Code. The Franchising Code is a voluntary code adhered to by reputable franchisors. It is administered by the Franchising Code Administration Council. The scheme came into operation on the 1st February 1993. Franchisors who apply and who are approved and who promise to adhere to the Code are given a code number. The Code itself is a lengthy document and sets out principles to be adhered to by the franchisor in his dealings with a franchisee or prospective franchisee. Ask your intended franchisor whether he is a member of the scheme and, if so, ask him to quote his registration number. Under the Code, the following rules apply.

There is a "cooling off" period of seven days from the date of the signing of the franchise agreement.

Where a dispute arises between the franchisor and the franchisee, they must first endeavour to settle the dispute themselves. If they cannot, the Franchising Council will appoint an arbitrator who will decide the matter. This saves the dispute from going to Court where heavy legal costs would be incurred by both sides.

The franchisee must inform the public by signs on his premises and on his stationery that he is a franchisee.

Franchise advisors must state their qualifications and disclose if they are being paid a commission by any business that they recommend.

Banks and financial institutions who register under the scheme must not provide finance to any franchisee who is buying from an unregistered franchisor.

The media, including newspapers, who register under the scheme must not accept advertisements from unregistered franchisors.

Before signing the franchise agreement, each franchisor must certify that the franchisee has received and read the following documents: 1) Disclosure document (see below), 2) a Franchise Guide published by the Council, 3) a copy of the Code of Practice. Before signing the agreement, the franchisor must require each franchisee to produce a certificate from a solicitor who must state that he has explained the franchising agreement to the franchisee.

As stated, each franchisor must provide to the franchisee a Disclosure Document. It must contain the following information.

Name and registered office of the franchisor. He must also state if he is a member of the Franchisors Association of Australia and New Zealand.

Names, job description, qualifications of the franchisor's principal officers including directors.

A detailed resume of the business experience of the franchisor and its principal officers including a) length of experience in the type of business offered in the franchise, b) length of experience in operating in operating or offering the franchise, c) length of experience in operating or offering other franchises and a description of those franchises.

The latest two Balance Sheets for the franchisor's business. Also, he must disclose the operating profit, after tax, for each of these two years. Where the sale is from an existing franchisee to a purchaser of the franchise, then the existing franchisee must provide copies of the Profit and Loss Statement of the franchise for the past three years.

Details of any civil or criminal or bankruptcy proceedings regarding the franchisor or its principal officers.

Details of the nature and period of existence of the franchise system and how it has developed.

Examples of any logos, trade marks etc used in the franchise and details of any steps taken to protect these and details of any pending litigation concerning these.

Details of payments to be made by the franchisee to the franchisor and methods of calculating the payments. Amount to be refunded by franchisor if franchisee terminates agreement during "cooling off" period.

Details of any restrictions, e.g. territorial, or offer on competing franchises, imposed on the franchisee.

Summary of the terms and conditions for purchase of services, goods, fixtures, property etc from the franchisor. Summary of situation if source of goods from franchisor fails. Relevant information regarding rebates etc from suppliers.

Basis of franchisor's involvement/approval for site selection.

Summary of terms and conditions relating to termination, renewal, goodwill and assignment of the franchise.

Summary of the main obligations of the franchisor including initial and ongoing training to be provided.

A tabulated list of components making up the franchise purchase e.g. franchise fee, stock, fixtures, fittings, working capital etc. Individual cost of each component must be stated and the total of all components shown. Also, a summary of those items which could be leased and estimated costs involved.

Details of any financial requirements by the franchisor of the franchisee e.g. a specific amount of non- borrowed capital towards the franchise purchase price.

Number of existing franchises and company or principal's outlets. A list of existing franchises including address, phone number and year commenced business. If this is impractical, a list of all franchisees in the State.

Details of number of franchisees terminated or not renewed over the past year. Details of any existing litigation with existing or former franchisees.

Where written projections of potential sales, income etc are provided to the franchisee, then the basis of these assumptions must be stated.

Statement as to whether the territory to be franchised has been subject to any previous franchised trading and, if so, the history of that trading.

If the franchisor you are evaluating is not a registered franchisor, then you should obtain the same information as above from him. In addition, you should be more vigilant.

The Code does not absolutely require the following information but you should obtain it as a matter of prudence.

A projection of sales, expenses and net income for the franchise being sold.

Details of any finance packages available to you. Sometimes franchisors have standing agreements with financial institutions to provide finance to franchisees.

You should pay particular attention to the following matters.

First, carefully read all of the Franchise Agreement.

Pay careful attention to the upfront fee. Beware. If there is a large upfront fee and a small ongoing fee, you may be dealing with a "shark". His objective may be to get as much money as possible and be gone. On the other hand, it could also mean that the franchise is very profitable. What are the ongoing fees such as royalties, advertising levy?

How much training will be provided for you and your staff?

How much advertising and promotion will be provided?

What territory are you being offered? Is it exclusive?

How long is the initial franchise period for?

What are the provisions regarding termination of the franchise by the franchisor? Is compensation payable on termination? In recent times, some franchisees of petrol outlets have had their franchises and leases terminated by the oil companies and they have received no compensation for the loss of their businesses. You should ensure that on any sale or termination of the franchise, you will be the person who will reap the value of the goodwill. Can the franchisor take over the business premises on termination?

Can you sell or assign the franchise during the currency of your agreement? Is the consent of the franchisor necessary for a new owner? Do you have to offer the franchise to the franchisor first before trying to find a buyer? If so, at what price?

What provisions are there for renewal of the franchise?

Now, that you got all the information that you wanted from the franchisor, what else should you do?

The most valuable thing you can do in checking out a franchise is to talk to some of the existing franchisees. Pick some at random. Do not be forced by the franchisor to choose from a small number. These could be his friends. Go the franchisees' premises. Observe the operation. Ask their opinions of the franchise. Find out what income they are making, what support they are receiving from the franchisor and what hours they work. Before finally committing yourself, ask if you could work in a franchise for a short while.

Find out what competition you will have.

Visit the head office of the franchisor. Observe how the operation is run and see what impressions you come away with.

Consult the Franchisor Association of Australia (FAA).

Carry out a search of the franchisor company at your local Australian Securities Commission office.

Enquire at your local office of the Trade Practices Commission. They may have some information on your proposed franchise.

Enquire at your local Consumers Affairs office. Again, they may have some information.

Consult a credit reference association. The information they can now provide by law is restricted but they may be able to provide you with some information.

Try to find out it there has been any litigation between the franchisor and some of his former franchisees.

Enquire at your local Chamber of Commerce.

Go along to your State Small Business Agency and discuss it with them.

Talk to your accountant.

If you carry out nearly all of the above suggested testing procedures and, in particular, if you speak to a number of existing franchisees, then you are much more likely to make an informed decision and reduce considerably the chances of being taken by a "shark".

          
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