"LOOK before you LEAP" by Miles Agmen-Smith and Alistair Van Schalkwyk (Franchise New Zealand magazine Year 24 Issue 2, 2015)

Articles: Franchising Articles

"LOOK before you LEAP" by Miles Agmen-Smith and Alistair Van Schalkwyk (Franchise New Zealand magazine Year 24 Issue 2, 2015)

Link to article here.

Buying a property may be the single most significant purchase you will make in your life, but your most significant asset is your ability to generate an income. This means that buying a business will probably be the single most important investment decision you will ever make, so you need to take care. Unfortunately, some people don’t.

Picture this: you have just resigned from your job, where you had a steady wage, and have mortgaged the family home to finance a franchised business. This may include paying initial franchise fees, fit-out costs and signing a franchise agreement and a lease.

You’re a bit nervous and it will be a while before your new business is making money, so you don’t want to spend more than you need to. One area where you think you can save money is by doing your own due diligence rather than using professional advisors. After all, it’s a well-established franchise with plenty of franchisees, so everything will be fine – right?

Unfortunately, the answer is, ‘Not necessarily.’ Nearly every franchise, including well-known brands, has a mix of thriving, surviving and failing franchisees. You’ll want to be one of the successful ones, which means checking things out carefully and ensuring you’re supported both legally and financially. Do you have the wide range of business skills and franchise industry knowledge to do it yourself?

the big issues

It’s important to consider all the following, as well as many other factors, before you take up a franchise. This list is just a start.

Terms of the franchise agreement:

• rights and obligations of both parties

• length of the term and whether there are rights of renewal

• initial and ongoing fees payable, including on renewal of the franchise

• initial and ongoing support to be provided by the franchisor

• the extent of any non-competition clause

• any territory granted and whether it is exclusive.

Terms of any lease:

• ensuring the term of the lease aligns with that of the franchise

• personal guarantees required

• rent review provisions and the effect of ratchet clauses.

Arrangements with employees:

• in an existing business, are you taking over all or some of the employees?

• staff employment: casual, fixed term, or permanent

• avoiding common pitfalls when engaging employees.

Terms of the business purchase agreement:

• what assets are included with the purchase.

Financial considerations include:

• for new businesses, the financial performance of comparable franchisees together with your accountant’s financial model

• for an existing business, the financial performance of the business over the past two to three years.

In either case, will the business make enough money to:

• pay yourself a market wage

• repay the capital invested over the term of the franchise

• provide a decent profit for your risk.

get clear at the start

If you are buying a franchise, your key aim is making money out of what you buy. The legal terms of the franchise agreement and any other legal documents, such as leases, are the recipe which determines what money you can make out of it. A franchise is a special kind of business structure and specialist knowledge is required. Too often, we meet with franchisees looking to exit their business because it is not financially successful or it is not what they thought they had signed up for. We generally find that they never really considered all the above aspects before signing up – either because they did not know what questions to ask, or didn’t know what to look at to see if the business was actually suitable for them.

Exiting a franchise can be difficult and costly. You need to find someone to sell to and this requires lessor and franchisor approval. You will be unlikely to recover the costs you have incurred, and it can take some time before you find either another business opportunity or a job to provide substitute income.

The message is: you don’t know what you don’t know. Using a professional advisor like ASCO Legal, in conjunction with other appropriate professionals, can make sure you understand the reality of the transaction and give you the best possible chance of success. If you’re investing your most significant asset – your future income potential – make sure you’re taking the best advice.