Mark Sherry, Partner, Harmans Lawyers New Zealand
A franchise is a special type of business and people should do appropriate background research and due diligence when they are considering the purchase of one.
The way franchises operate isn’t for everyone, and like everything else in the world, not all franchises are created equal. Some are much better than others.
There are a lot of resources and expertise available for franchise buyers to access for assistance, if only they know where to look. A few of these sources are discussed below.
Franchise Association of New Zealand
The Franchise Association of New Zealand (FANZ) is a voluntary organisation that New Zealand franchise systems can join. Membership requires those franchise systems to, amongst other things, have their franchise documentation vetted and approved to meet minimum standards from a fairness prospective. Those franchise systems must also subscribe to the FANZ Code of Practice and Code of Ethics. Where a franchisor is selling a new franchise operation, the franchise agreement must contain a cooling off period allowing a prospective buyer to walk away from a transaction within seven days of signing the agreement if they change their mind. Therefore, there is a good expectation that buying a franchise from a member of FANZ will result in the documentation of the franchise being reasonably fair and equitable, with a robust and fair dispute resolution process that can be followed if issues do arise.
FANZ however goes further in offering resources to people interested in buying into a franchise system. In addition to helpful publications it has produced, it has links to a portal on its website that it has set up in conjunction with Massey University which is effectively a franchise pre-entry education programme. There are modules and videos covering topics such as franchising basics, the money side of franchising, systems and start up, operating and support, and due diligence. All of these topics are extremely relevant to gaining an understanding of the basics of franchising. They can help a person assess whether they believe franchising is right for them. It has often been said that people with an entrepreneurial streak are not necessarily well suited to franchising because, whilst a franchise operator is running their own business, they are strictly bound by rules, processes and procedures that must be followed. People who want the freedom to operate their business as they choose should look for business opportunities elsewhere. Franchises are more suited to people who wish to operate their own business, have some business experience (whilst not necessarily having operated their own business before) and want to be systematic and willing to follow a model.
An excellent place to start looking for general business information, particularly if you are going into business for the first time, is the website www.business.govt.nz. As well as having a lot of general information and advice on what to do and who to approach if certain situations arise in business, there is a great deal of commercial, tax, legal, accountancy and management advice all bundled into one coherent website. This website has tools for business plans, tax and compliance advice, mentoring links and management advice, as well as basic information on employing staff and appropriate business structures.
The information on this website is general by nature and does not profess to have all the answers or to supersede advice that you should take from your lawyer or accountant. However, it is an excellent window into concepts that should be understood by a business owner and it gives some basic information which will help the reader school up on areas that they are unsure of. Having some basic knowledge will also lead to more in-depth discussions with your professional advisors, which in turn will more likely lead to better decisions being made in a more timely and cost effective manner.
Specialist Franchise Lawyer
Most lawyers are capable of looking at a franchise contract and telling you what it says. However, the difference between lawyers without specialist knowledge and a specialist franchise lawyer is that a specialist knows what to look for in a franchise agreement that might raise warning signs. Even more importantly, they also know what should be in an agreement even when it is absent. A specialist franchise lawyer will be able to talk to you about issues that fit into the bigger picture surrounding your franchise business and how they should best dove-tail together, (for example, issues such as the leasing of premises, the employment of staff, business structures and financing) and they will be able to talk to you about experiences they have seen in the franchise sector, what in the franchise agreement is fair and reasonable and what issues might raise warning bells.
One of the biggest issues that people fail to think about when entering into a franchise agreement is what their exit plan is and what their rights and obligations are when their franchise comes to an end. By entering into a franchise agreement which has particularly onerous terms, a franchisee may find that they are bound to it for a considerable period of time, they are obliged to pay fees through that whole period regardless of how the business is trading and, because of the nature of the franchise document, it may be hard to sell to anyone else. Finally, there are often restraints of trade and restrictions on what the franchisee can do when the franchise comes to an end. These can often be particularly onerous. For example, there is little point taking an existing plumbing business into a branded franchise system in order to increase public exposure and increase the client base for a 10 year period to then find that upon the expiry of that period, the client base belongs to the franchisor and the plumber is restricted from plying their trade within the city where they had been operating. Obtaining expert legal advice when it comes to franchising is crucial.
Expert Franchise Accounting Advice
Specialist franchise accountants tend to understand the upfront costs involved in going into a franchise, as well as the ongoing fees and obligations involved in operating a franchise. They can help prepare budgets and analyse cash flows, utilising their knowledge without having to school themselves up on how franchises operate. This in turn will provide their clients with the ability to work out how much is needed to buy, set up and run their franchise, either prior to signing a contract or during the due diligence phase. They can then determine if it is affordable to purchase the franchise and, even when it is affordable, they can provide good advice to their client on the likely profitability, the risks involved and the likely time and effort that will need to be invested, particularly in the early stages while the business is being established. Just because a franchise system is involved and there is support and advice in the background, this does not negate the need for a new franchisee to have lots of drive and a willingness to put in long hours and face challenges in getting their business off the ground. All franchise disclosure documents have exclusion clauses recording that there are no guarantees as to the likelihood of the success of the franchise and that the franchisee is purchasing it, after taking appropriate advice, at their own risk.
It is not uncommon for people having taken expert accounting advice to make a decision not to proceed with a particular franchise purchase after the accountant has helped them weigh up the likely profitability and the risk. They may decide that they would be no better off than continuing in their existing role (especially if they are employed and a regular income is guaranteed), as opposed to taking the risk of being in business, which may mean that their income could actually drop even though they are working harder than ever.
Specialist Franchise Bankers
Many mainstream banks these days have set up specialist departments to deal with franchising. Particularly when it comes to bigger franchise brands, these specialist banking teams have analysed many systems and the way they tend to operate. This research gives the bank a good idea of how likely the business is to succeed. These specialist banking teams are more likely to recognise the benefits of a successful franchise system and assist with the funding requirements of a buyer. Further, good senior bankers are often an excellent sounding board for commercial queries. They can therefore provide good, impartial commercial advice at the same time they are discussing funding applications. Whilst most banks are still bound by their overall credit criteria, it is not uncommon for members of decent franchise systems to actually have been approved to borrow at higher lending percentages than may otherwise be the case for an independent business, just because the bank’s due diligence shows the likely success levels of the franchise system. Generally, a franchisor will be able to point a franchisee in the direction of any bank that has assessed their system and is willing to assist in this way.
As a wise man once said, “To succeed in business, one needs preparation, dedication and hard work”. When looking to purchase into a franchise system, one of the smartest moves would be to utilise the modules and portals described above to school up on franchise and business issues, and to then take good advice from appropriate professionals so that you have the best chance of success. The dedication and hard work that then needs to follow has to come from within!
Mark Sherry, LLB (Hons), BCom, is a Partner with Harmans Lawyers New Zealand. He leads the commercial and property team, specialising in franchising, hospitality, rural law, property matters and asset protection. Harmans is a full service legal firm providing excellent service and advice, allowing Harmans to develop long-term, solid relationships with their clients.
For more information please contact Mark Sherry at:
Phone: +64 3 352 2293
Mobile: +64 21 524 890