Im Buying a Franchise. What Due Diligence Should I Do?

by 6th of February, 2020

Are you considering buying a franchise? If so, the process is a little different from purchasing an existing, independently run business. When buying a franchise, you are not simply buying a business, but you are entering into an ongoing business and legal relationship with the franchisor which will last for the agreed term of the franchise. Accordingly, there are different issues you need to consider. This article will go through a few of the key areas of due diligence before buying a franchise.

Understand the Risks and Rewards

When you express interest in buying a franchise, the franchisor must provide you with an Information Statement. If they do not supply you with one, you should request a copy. The Information Statement is a short document which sets out some of the risks and rewards of becoming a franchisee.

It can be very rewarding to run your own business with the support of an established business system. Prospective franchisees should be aware that the franchise agreement will usually incorporate strict performance standards setting out how you conduct business. When you buy a franchise, the franchisor grants you the right to run a business using their brand, intellectual property and existing business systems. The success of the franchise brand relies on all franchisees running their businesses consistently with the brand and its business systems.

There are also free, online education courses available for prospective franchisees if you want to understand the business model in more detail.

Research the Market

In addition, you need to independently evaluate the information given to you by the franchisor, primarily relating to the success of their business brand. One way to do this is through speaking to current and former franchisees.

Existing Franchise

If buying an existing franchise, you should at least make enquiries to find out:

How long has the business been running in that same location?
Are there any other franchises in the same suburb?
What are the boundaries to your territory? (e.g. what suburbs fall within your territory?)
Will you have exclusive territory?
What are the ongoing fees in the franchise?
What sort of changes (if any) has the franchisor made to the ongoing fees in the past?

New Franchise

If buying a new franchise, there will be less information available about the location of the franchise. However, you should still make enquiries to find out:

How long has the franchise been in operation?
How many franchises currently exist in your city?
In terms of location, what is the spread of the existing franchises in your city?
Will you have exclusive territory?
What are the ongoing fees in the franchise?
How competitive is the pricing of products and services?
Who are the potential competitors in your territory?
How similar are the products and services offered by potential competitors in your territory?

In addition to speaking with existing franchisees, you should also look on the franchisor’s website and social media pages. For example, reviews on Google can give honest insight into the way a franchise runs their business and whether it has good standing in the community. Food delivery and sharing apps such as Deliveroo and Zomato can also provide honest insight into the local popularity of a food, retail or hospitality business.

Once you have evaluated the pricing and expected market, you will be in a better position to consider the fees in comparison with the potential revenue.

Assess the Financial Documents

If you are buying an existing franchise, you may receive copies of the financial documents for the current franchisee. These will be specific to the location of that franchise. Alternatively, if you are buying a new franchise, you will need to rely on the franchisor’s general financial documents.

You should try to prepare a business plan and cash flow forecast using the information in the disclosure document. You should also enlist professional help from an accountant or accredited business expert in this area.

Check Ongoing Support

Referral networks, ongoing social media engagement and business promotion are important for maintaining strong business performance. Ongoing franchisor support is usually available whether you are buying an existing franchise or a new franchise.

Asking questions about the franchisor’s marketing strategies can help you to anticipate their level of ongoing involvement. This can help to set your expectations about the type of business support you will receive.

Consider the Proposed Lease Arrangements

Whether the franchise you are looking to buy operates from a store, warehouse or other commercial space, you should ask questions about the current lease arrangements with the landlord. This leasing arrangement may look quite different from your typical landlord-tenant relationship.

At the very least, you should make enquiries into:

the terms of the lease;
whether the term of the lease matches up with the term of the proposed franchise agreement; and
whether the lease be renewed and whether this presents any difficulty to the conduct of the franchise.

Common leasing arrangements include:

the franchisor holds the lease as tenant;
the current owner holds the lease as tenant;
you will keep the lease as tenant when you takeover; or
you are required to find commercial premises to lease.

If the franchisor is the tenant of the premises, you will be provided with a sub-lease agreement or licence agreement instead of a lease agreement. Both of these documents mean that your rights to occupy and operate the business from the property are going to be set out by reference to your agreement with the franchisor and the terms of the document that they provide to you. Therefore, it is essential to seek professional legal advice from a leasing lawyer before you sign these documents.

Know the Obligation to Act in Good Faith

The Franchise Code of Conduct requires both the franchisor and franchisee to act in good faith during commercial dealings with each other. Franchisors have a duty to act honestly during negotiations before you sign a contract.

However, you should not rely on this and believe everything they tell you. You should contact existing franchisees and verify that they are happy with the business model and franchise system and make sure the system has a track record of success.

Key Takeaways

Buying a franchise requires more consideration than buying an independently run business.

When undertaking due diligence, it’s important to research the:

commercial viability of purchasing a franchise;
company’s brand reputation using their social media and website;
level of ongoing support offered; and
obligations on yourself and the franchisor in Franchise Code of Conduct.

If you are buying a business, it's important to consider the business due diligence related.

Require Legal Assistance with Buying or Selling a Business? Bsale has teamed up with Legal Vision to help you in the process. Receive a FREE QUOTE FOR BSALE CLIENTS on fixed priced services.