Franchising as a method of marketing goods and services is exciting and there are many business opportunities available. It is essential for any prospective franchisee to look carefully at a business opportunity which involves carrying out due diligence. Purchasing a new franchise system and being one of the first franchisees off the block can be groundbreaking but great care must be taken.
Trending franchises which may be appealing often involve food and fitness. For example, Cinnabon, Jamaica Blue, KFC, Snap Fitness and Anytime Fitness.
Once a franchisee has identified a particular business to buy then the services of an experienced franchising lawyer and a business savvy accountant are essential. Whether you are buying a home services franchise or a full business format franchise does not matter – your due diligence is the same and you must be careful to ensure that you can afford the purchase price which often includes goodwill, plant fittings and fixtures, and stock. If you elect to purchase a greenfields opportunity then you will have to pay the upfront franchise fee to the franchisor.
What Must You Do?
Identify the chosen franchise system and you will be asked to sign a confidentiality agreement or an NDA. If you are buying an existing business through a business broker, you will often be provided with an information memorandum. Whatever you purchase, make sure you can afford the total purchase price including having a working capital provision to cover upfront lease rental payments, legal and accounting fees, necessary equipment purchases plus money in the bank to get you through the first 3 to 6 months.
Most of the banks are used to franchises and like them, especially ASB, ANZ and Westpac. With well-known and successful systems, banks may be happy to provide finance subject to a satisfactory personal position from you as a prospective franchisee plus cashflow forecasts. It is good to borrow from a bank when purchasing a franchise as that will ensure an ongoing commitment and discipline with the bank in relation to repayments; but do not over-extend yourself. There is nothing worse than feeling pressured to pay creditors with no buffer. Banks will usually require loans for franchising repaid within five years so your forecasting must build that time frame into account.
Good cash flow management is essential for any business. Of course, due regard must be given to any specific legal requirements of the franchise system. For example, if you were to purchase a business involving food there are strict regulations in relation to food hygiene and food management.
An important point to note in regard to today’s world of multi-communications is you must always be aware of the power of social media, especially Facebook and Instagram.
Franchising is well understood and accepted in both Australia and New Zealand, and according to the 2024 Survey of Franchising in New Zealand, it covers a wide range of industry categories including retail trade, accommodation and food services, and administration and support services.
Franchise Agreement
The key legal document is the franchise agreement. Many clauses which are usually included in the agreement include the following:
- Grant of franchise
- Term of the franchise
- Rights of renewal of term
- Obligation to pay royalties and advertising fees to the franchisor
- Minimum performance criteria
- Good faith obligations on the part of a franchisee and the franchisor
- Not to prejudice the franchisor’s intellectual property
- Customer database and privacy
- Customer complaints
- Franchisor’s obligation to conduct extensive training
- Franchisor’s obligation to provide the manuals which should include the operating manual and health and safety manuals
- Dispute resolution recommending mediation
Australia is far more regulated than New Zealand with a mandatory disclosure regime. Prospective franchisees can rely on the disclosure document and whatever is stated in it. Therefore, all statements and representations made by any franchisor must be true.
To go into franchising, the message is clear – do your homework by way of due diligence, ask the right questions of a franchisor, have a bank behind you which provides necessary finance, and obtain expert accounting, taxation and legal advice. A monetary investment in the due diligence process is essential as you need to know what you are getting into and what your continuing obligations are. However, above all – do not over-extend yourself by paying too much for a franchised business when you really cannot afford it.
Stewart Germann
Franchising Lawyer
Auckland, New Zealand
