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What you need to know before buying a franchise

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Franchising is big business for the nation’s army of small entrepreneurs.

Australia has three times more franchise outlets per capita than the US, with 79,000 franchised outlets which rake in a combined annual turnover of more than $146 billion and collectively employ 470,000 people.

Stroll through any retail centre and it’s a fair bet you’ll run into well-known franchises such as McDonald’s, Subway and Jeanswest.

Franchising is thriving in other industries too – everything from pet supplies, car care and home maintenance through to bookkeeping, mortgage broking and real estate.

But is it still a wise business move?

Off to a strong start

Investing in a franchise gives small enterprises the benefit of a well-known brand, something that can take years for an independent venture to build up, as well as the proven business systems of the franchisor.

According to Dominique Lamb, CEO of the National Retail Association (NRA), 80% of independent small businesses fail in the first five years – “that’s far higher than the 20% failure rate among franchisees”.

The advantages of franchising go beyond an established brand. “As a franchisee you’re not entering a new industry on your own,” says Lamb.

“You have the support of the franchisor, and this can extend to assistance with human resources, organising business bank accounts, which can mean securing discounts on equipment like EFTPOS machines. Franchisors will also often step in to negotiate leases for franchisees or at the least educate franchisees on how to negotiate a commercial lease.”

Simply being answerable to a franchisor can be a plus.

“Many people love the idea of working for themselves but they don’t always have the necessary discipline to be small business operators,” says Michael Russell, managing director of franchised mortgage broking group MoneyQuest.

Are you cut out for it?

Despite the benefits, franchising is not for everyone, and it can be surprisingly competitive just to be selected as a franchise.

Good franchisors are highly protective of the brand they have built up and, not surprisingly, many actively seek out people who will be enthusiastic brand ambassadors.

Even if you have the right personal qualities, you need to commit to playing a very hands-on role in the business and that inevitably means long hours at the coal face.

“Be prepared for hard work,” cautions Lamb. “A franchise is not a way to make money without you being involved. You have to drive the business, make your mark on it and lead by example, especially when it comes to motivating staff to give their best effort.”

Breaking into a new industry

So far, so good. But what if you’re also hoping for a complete career change?

It’s common to see claims of “no experience necessary” in franchise marketing material. These can seem too good to be true, yet in many cases the claims are entirely accurate.

Starting a business in an industry where you have little or no experience may make for a refreshing career change but it is critical to look closely at the amount and quality of training you’ll receive.

The more extensive the training program, the greater your odds of success. Some franchisors charge for training, and as you won’t be paid for time spent in initial training and induction programs you will need cash savings to tide you over this period.

Not all franchisors embrace industry newcomers. Angus Raine is CEO of the Raine & Horne property group, which has been a franchisor for over 40 years.

“We are a mature franchisor in an industry-specific space, so we only recruit franchisees with real estate experience and a proven track record of sales,” he says.

How much it costs

Along with a healthy dose of enthusiasm, it takes a fair amount of cash to buy a franchise. According to the Franchising Australia 2016 report by Griffith University the average upfront fee for a retail franchise is $31,500 and $28,000 for non-retail franchises.

This fee comes on top of the capital required to fund shop fitouts, plant and equipment, inventory and lease commitments – these are paid for by the franchisee, not the franchisor. The report notes that the total start-up cost for a new retail franchise is around $287,500 compared with $59,750 for a non-retail franchise.

These are averages, however, and at the top end of the scale establishing a new Bakers Delight outlet can cost up to $550,000, while McDonald’s Australia advises would-be franchisees to have unencumbered cash of at least $1.2 million.

Along with the initial fee, franchisees also pay ongoing costs to the franchisor, including royalty fees – generally based on 4%-10% of turnover, or a fixed amount.

Separate costs such as marketing fees can also apply. As fees are a leading source of dispute between franchisors and franchisees, it is critical to understand exactly what you will be up for in initial and ongoing costs.

Which franchise is right?

With 1120 franchised brands to choose from in Australia, it can be hard narrowing down the business opportunity that suits you.

“Anyone thinking about a franchise should consider whether their personal values align with the brand,” says Lamb.

You will also be expected to toe the franchisor’s line in terms of products, pricing, uniforms and even signage – something that can quickly become a grind if you’re not truly committed to the brand.

Another issue to consider is the earnings potential of a franchise. By law franchisors cannot make specific statements about how much you will earn, though they can provide a range of indicative earnings.

“People tend to look first at what a particular brand is offering, like, say, the chance to work outdoors,” says Michael Russell. “The income-earning potential often runs second but it’s important to get both right. Ask yourself if the earnings potential is sufficient for your needs.”

The onus is on you

Once you’ve found a franchise that ticks all the boxes, the next step is due diligence. Research the business as much as possible to be sure it is a sound investment, and don’t scrimp on expert advice.

“Increasingly we find prospective franchisees are closely examining the franchise disclosure document, making inquiries about costs and fees, and asking to see demonstrations of our technology and an outline of our professional development training program,” says MoneyQuest’s Russell.

“That’s a good thing. We want franchisees to come into the business with their eyes wide open in terms of the obligations and entitlements of both parties.”

When it comes to reviewing the franchise agreement, it is worth seeking out a solicitor who specialises in franchising.

This may add to the upfront cost but it could spare you the expense of investing in a dud or becoming embroiled in a dispute further down the track.

Russell says franchisees should ask two important questions: “First, is the brand a member of the Franchise Council of Australia [which imposes ethical standards for franchisors]? If it’s not, that’s cause for concern. Second, is the information set out in the franchise disclosure document consistent with what has been spoken about in the lead-up discussions? Any differences between what has been said and what is in writing should set the alarm bells ringing.”

Some basic investigative work can also confirm whether the reality matches the hype.

“Speak with existing franchisees to see if the opportunity has lived up to expectations,” advises Russell.

Danger zones

Like any relationship where money is involved, things can get rocky between franchisees and the franchisor.

According to Griffith University, 1.8% of franchisees have been in dispute with their franchisor over the past two years, and the most common grounds of disagreement are franchisee compliance, communication and fees.

Having the franchise agreement reviewed by a solicitor will give you a firm understanding of the rights and responsibilities of both parties, particularly regarding fees.

However, the issue of compliance is less clear cut. It can be frustrating to have to follow a franchisor’s directives, especially if it means investing your own money in new uniforms, logos or products you don’t necessarily agree with.

And you may have limited scope to introduce new initiatives without the franchisor’s approval. The bottom line is that if you feel strongly about following your own ideas, franchising may not be for you.

A potentially far greater risk is the potential for the reputation of your own business to be impacted by the actions of other franchisees. We saw this recently when the Fair Work Ombudsman found a number of 7-Eleven franchisees had underpaid their employees and falsified store data.

The highly publicised scandal has drawn significant negative attention to the overall brand, and NRA’s Lamb believes the 7-Eleven debacle has “really had an impact on the concept of franchising”.

Interestingly, the ombudsman found 7-Eleven exerted a high degree of control over its franchisees’ businesses, including requiring them to maintain specific stock levels and participate in certain promotions at the franchisees’ expense, yet failed to provide meaningful compliance monitoring or auditing of the stores.

This makes it important to ask about the quality of compliance checks performed by a franchisor.

It may be a hassle for you as an individual entrepreneur but a high level of compliance monitoring across all franchisees could go a long way to protecting the value of your business.

A difference between what has been said and what is in writing should set alarm bells ringing

Franchising in numbers

• 1120 different franchise brands operate in Australia.
• 90% of franchised brands originated in Australia.
• Annual sales turnover for the franchise sector is estimated at $146 billion.
• One-third of franchise brands engage in online sales.
• 26% of franchise brands are in the retail (non-food) industry.
• 19% are in accommodation and food services.
• 60% of franchise brands have been franchising for more than 10 years.

Source: Franchising Australia 2016 report, Griffith University – Asia-Pacific Centre for Franchising Excellence.

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