Buying a Franchise - What questions will your lawyer ask you?
The following article was written by Mark Sherry and first published in the Business Franchise Australia and New Zealand magazine.
1. Why are you buying this franchise?
This is a very broad question and when your lawyer asks it, they are looking to gather an understanding of your reasons for entering into the purchase of the franchise. They are also trying to ascertain how much you understand about the franchise, what your obligations will be and how well you have weighed up your options and alternatives.
There are many reasons for buying a franchise, but buyers also need to be aware that when entering into a Franchise Agreement there are restrictions placed on the way they can behave and that each franchise only lasts for a limited time in most cases. At the very least, a buyer should always consider their options which may include buying a similar business that is not part of a franchise system, or starting up their own business. Generally, the reason people enter into a franchise is that the brand awareness and established systems give them a huge upfront advantage over someone who follows one of the alternatives. It should be noted, however, that just because a franchise system has advantages over other options, you need to ensure that you are a fit with that system too. You need to be prepared to walk away if the requirements and controls placed on franchisees by the franchisor would be more than you could bear, or where you may be concerned that you do not possess the special attributes or skills required by a franchisee to make a success of that business.
Your response to your lawyer needs to show that you have given reasonable thought to the alternatives and that on balance the purchase of the franchise is something you wish to pursue.
2. What do you know about the franchise system?
Franchises come in many shapes and sizes. No two franchise systems are the same and each one has its strengths and shortcomings. It is important to recognise this and to carry out a due diligence investigation on a franchise system so that surprises are minimised when you do become a franchisee. One of the best ways to find out about a franchise system is to speak to existing or former franchisees. Other franchisees who have had time in the system will already know many of the things you are trying to find out and you will be able to establish from them their views on issues like the support and training offered by the franchisor, the effectiveness of advertising, shortcomings in different areas and the franchisor’s responsiveness to rectifying these. You will often find some franchisees who praise the system and others that, for one reason or another, are disgruntled with it. You need to receive the comments of these people with an open mind, but overall they will give you a good impression on how the franchise system is run.
Another way of finding out about the franchise system is to review a disclosure document for that system. Disclosure documents exist for some systems, especially those that are members of the Franchise Association of New Zealand. They provide details on many issues surrounding the franchise system, including how many years it has been in operation, how many franchisees there are and what the franchisor’s background is. There may even be financial projections included within that document.
It is important to know the background of the franchise system as many systems are introduced to New Zealand from overseas. There have been cases of systems introduced here which have not fared well. This is even true of systems that have come from our close neighbour, Australia. Therefore, regardless of the size of the system and where it has come from, it is important to know that the system is proven in New Zealand conditions. If you are looking to purchase one of the first franchises of a system being introduced into New Zealand, then that may be a good reason to negotiate a substantial discount or concessions up front as you would be bearing the risk of establishing whether the franchise will succeed in New Zealand or not.
3. Have you had an experienced accountant review financial matters?
Many financial based questions raise their head when a franchise is being reviewed. Your lawyer will want to know that you have considered them and have taken proper advice before a final decision is made to continue with the franchise. Examples of the types of issues to review are:
- How much will the franchise cost?
- How is the purchase being financed?
- What are the ongoing costs for royalties, advertising and other payments to the franchisor?
- How much are the training fees?
- How much working capital is required?
- What can you earn?
It is not trite to say that having an accountant that understands the way that franchise systems work is critical. As mentioned, most franchises only run for limited terms which in turn means that the return on investment must be able to be recovered during the franchise term itself. Taking advice from an experienced franchise accountant can go a long way to ensuring that the franchise you are buying is likely to be financially viable and successful.
4. What ownership structure are you considering?
Having a well thought out ownership structure for your business and lifestyle assets can be very beneficial. When buying a franchise, you will need to consider whether you trade in your own name personally, or whether you form a company. You will also need to consider the best structure for the shareholding of any company if you decide to form one. There can be many situations where it will be advantageous to include a trust as a shareholder of your company.
Similarly, it is always important to consider the ownership structure of your lifestyle assets when you are self-employed. In business you often find yourself having to give personal guarantees to the likes of franchisors, banks, landlords and key suppliers. Should your business fail for any reason and a guarantee is called up, then potentially all of your personal assets can be exposed to the creditors you have provided guarantees to. Accordingly, there can be merit in utilising a trust to own lifestyle assets too. It should be noted that even after a business is sold ongoing contingent liabilities can still exist. This often occurs with leases of premises that are ongoing. If you have sold your business and assigned the lease to your premises and then the future owner of the franchise has their business fail, the landlord may come back to you and attempt to claim unpaid rental and outgoings from you as a prior tenant.
Your franchise lawyer will want to discuss these risks with you and make sure that you understand them. They will also want to assist you in creating the best ownership structure for your business and lifestyle assets to take account of any advantages that can be had and to minimise your exposure to risks.