Disadvantages of buying a Franchise
Greyson Legal | Franchise Lawyers
There are risks to buying a franchise. Conducting proper checks and engaging specialist franchise lawyers can minimise this risk.
Here are a few risk factors to consider as a franchisee in respect of belonging a franchise system:
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Franchise Network
Being part of a franchise network is not only an advantage, but may also be a disadvantage. For example, poor performance of other franchisees in the franchise network or bad publicity linked to the brand itself can impact negatively on the network as a whole, the reputation of the Franchisor and your Franchised Business.
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Limited Creativity
Becoming a Franchisee means you are part of a franchise network which follows a system of standardisation. As such, once you are a Franchisee you will have limited scope for originality or creativity as a Business owner. If you prefer flexibility and the ability to make your own decisions about how your Business operates - then franchising may not be the right fit for you.
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Restrictions
There are various restrictions set out in the Franchise Agreement in relation to the how the Franchised Business is to be operated during the Term, and what happens after the Term expires or by earlier termination. For example, in relation to restraints of trade. It is important to check these restrictions before entering into a Franchise Agreement.
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Suppliers
Use of Approved Suppliers are not only an advantage but can also be a disadvantage, especially if the price of their products are higher compared to other suppliers.
Rebates
Not all Franchisors pass on any rebates they may obtain through economies of scale - so checking with the Franchisor and the terms of the Franchise Agreement is essential.
KPIs (Minimum Performance Targets)
Key performance indicators (KPIs) are a tool that Franchisors often use to monitor franchisee performance.
A failure by a Franchisee to meet KPIs can lead to enforcement measures by the Franchisor including potential termination of the Franchise Agreement. When considering acquiring a Franchised Business it is critical to check these KPIs to make sure they are achievable and to ensure there is a reasonable process of enforcement when KPIs are not met.
Fixed Terms
Usually Franchise Agreements are only for a fixed initial term followed by one or more "options" or renewal terms. Once that period ends the Franchisee:
may not be able to sell the Franchised Business;
may not be compensated by the Franchisor;
is unable to continue trading under the Franchisor's brand or use the Franchisor's know-how, etc.
As such, when buying a Franchised Business it is important to ensure the initial term and any renewal terms of the Franchise Agreement are sufficiently long enough to obtain a return on the investment.
Territory Selection
If territory selection or site allocation by the Franchisor has been poor, this could impact on profitability for franchisees - eg. by over granting territories within a particular geographic area.
Fees
There is usually an initial obligation to pay a Franchise Fee and ongoing obligations to pay other fees and costs, such as, royalties.
Premises Lease
Where a premises lease is involved, you maybe required to not only pay the ongoing rent and outgoing, but you may also have to pay for the initial fitout of the premises and and future refurbishments.
Default
If you breach the Franchise Agreement it could lead to the termination of your rights to operate a Franchised Business.
Franchisor Failure
Another factor to keep in mind is that franchisors themselves are not immune from failure.
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There are a number of franchise systems that operated in Australia and which ultimately failed and either had administrators or liquidators appointed or needed to re-structure. These include, for example:
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the jewellery chain – Kleins;
the Traveland chain of travel agents;
the delicatessen chain - Price Deli;
the real estate chain - Century 21 Pty Ltd
the white goods company - Kleenmaid Group;
the car care company - Midas Australia;
the furniture retailer – Samsara;
Caltex stepped away from their franchise model;
the pastry chain - Pie Face
These are just a sample.
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It is important to note, however, that the collapse of a franchisor does not inevitably lead to the brand evaporating or in fact that franchisees will also fail. For example, the Century 21 franchisees were able to continue trading under a new ownership structure and franchise model. A large number of Traveland franchisees were also able to continue operating either on their own account or as part of other travel agent chains. Some franchisees in other situations were able to form buying syndicates to acquire the franchise system and intellectual property and continue trading.
But, not all franchisees are so fortunate so this must be borne in mind. Either way it is a stressful time for those involved.
The lesson from these failures is that a franchisor or franchised system is not immune from harmful internal and external forces. As such, if you are a prospective franchisee you should undertake a thorough due diligence and obtain appropriate legal, financial, business and accounting advice before committing to a Franchise Agreement.