Making franchising your future
Gurmeet S Jakhu, partner at Knights Professional Services When it comes to investing in a business one of the most important things you can do is to carry out due diligence checks. There are a number of questions which you must ask yourself, your would be franchisor and advisers to check if the investment is viable one. Franchising is no different and in this feature, we look to break down the questioning process, and investigate the things you should clarify before you make an investment.
But first be aware of the maxim, ‘Caveat Emptor’
Caveat Emptor is an ancient cornerstone of the law in England and means ‘let the buyer beware’ Therefore, it is up to a buyer to make sure that what it is purchasing is what it is said to be by the seller. There are some circumstances where there will be limited departure from the caveat emptor rule, for instance misrepresentation and contracts of utmost good faith (like insurance), but these are few and far between.
Further given the reluctance by English courts to recognise an overarching duty of good faith in contract negotiations and performance, coupled with the fact that the UK has no franchise specific laws, means that buyers need to be very careful about what they are purchasing. A potential purchaser, whether of a new franchise from the franchisor or a re-sale of an existing franchise business, must carry out all relevant checks and undertake thorough legal, financial and commercial due diligence.
Tips for potential franchisees
Becoming part of a franchise network, with an established brand, if often seen as being less risky when compared to starting a completely new business. The franchisor will have a tried and tested business and its products or services should be widely known and recognised due to the franchisor’s previous advertising and marketing effort. Whilst it is possible for a franchisee to join a new franchisor, as a pilot franchisee, the drawback is that there will not be many other franchisees to meet when evaluating the franchise opportunity, although this may sometimes be addressed in the level of purchase consideration.
The success or failure of a franchise will largely depend on the effort made by the franchisee. A business owner, is likely to be more driven to make a success of the business venture when compared to an employee no matter how well remunerated. It is important to remember that a franchisee will have to follow the method and instructions provided by a franchisor, so if you are not the kind of person who likes following instructions then franchising may not be for you.
Due diligence will involve asking questions of a financial nature like:
1. How much total investment will this franchise require?
Whilst the franchisor should provide a response, also ask existing franchisees what their experiences were. A related question is what does this price include and what capital costs will be incurred in addition to the franchise opportunity cost.
2. How much will I need in working/operating capital?
Unless you purchase an existing business, you will not have any customers or revenue when you start trading, but you will have expenses. Until your revenue grows to cover these expenses, you will need access to liquid capital.
3. What will be the gross profit margin and what costs will I incur in arriving at a net profit?
Seek clarification as to whether the figures provided by the franchisor include your salary and depreciation.
4. How long will it take for my new franchise to reach break-even?
This is often met with a potential range of time, but it is prudent to plan that it will take the longest time.
5. You may also want to know how many business failures have been experienced by
franchisees - and ask for the reasons, as sometimes, it may be down to the individual franchisee rather than a systemic failure.
Other questions should include:
• How financially strong is the franchisor company?
• How much money will I make in this franchise?
• What are the ranges of financial performance of the existing franchisees?
Don’t be afraid to ask questions of existing franchisees. If your access is restricted this could be a sign that the franchisor does not want you to talk to some of its franchisees who may be disgruntled and disheartened with the way the franchise has developed. Ask for a list of all franchisees together with contact details.
The franchisor should be able to provide a response to the above and also present you with data and information relating to its franchisees performance and also forecasts. Use the responses to your questions and data provided to prepare a detailed and comprehensive business plan, with the assistance of expert advisors/accountants. Whilst most of the figures for sales and expenses should be available from the franchisor, the franchisor must be very careful when providing such figures to ensure that its set out the basis of the figures and that it has in place suitable safeguards to prevent a claim based on misrepresentation, arising.
If you are planning on raising finance from a bank, a business plan will be essential. It will provide a clear direction from the outset and is a living document, which will change along the franchise journey.
Legal Due Diligence
This involves asking a solicitor to review your franchise agreement. It is essential that you appoint a lawyer who specialises in franchising and who is affiliated to the bfa as they will know what to expect in such agreements and also understand the limited scope to challenge its terms.
I am often asked why have it reviewed if there is no prospect of it being changed. If you do not take legal advice, you will not fully understand what you are signing up to. The solicitor will be able to explain your rights under the agreement, your obligations, any performance targets, the franchisor’s right to terminate (which will be quite draconian), the financial and other provisions which you may not fully appreciate. A bfa affiliate solicitor will be experienced in reviewing franchise agreements and will be able to tell you if there is anything unusual or unreasonable that may require further explanation.
British Franchise Association (“bfa”)
The bfa is a self-regulatory trade body for franchising in the UK. In the absence of franchise specific legislation in the UK, the role of the bfa has added importance as the guardian of standards in franchising. It will vet all potential franchisors to ensure that the business, is viable, ethical and franchisable. The franchisor must also be able to demonstrate that the business concept has longevity and involves the transfer of know-how to its franchisees. All members are subject to annual re-accreditation and they must adhere to the Code of Ethics. The Code broadly covers advertising, recruitment, pre-contract disclosure and interactions with franchisees.
Whilst membership is entirely voluntary, you can be assured that all ethical franchisors and professionals affiliated with franchising in the UK, will want to be members, as it reflects a hall mark of accreditation and shows that we are prepared to adhere to what is considered to be best practice in franchising in the UK. So it is always pertinent to ask whether your prospective franchisor is a member of the bfa. If not, you should enquire as to ask why not.
The bfa has prepared a list of 50 questions to ask a franchisor before taking up a franchise opportunity and include questions about the financial position, operating methods, costs and your involvement. This is a must see for all would be franchisees.
The bfa in association with Lloyds Bank has produced a new free e-learning initiative called the Prospect Franchisee Certificate (PFC) aimed at delivering a comprehensive overview of what it takes to succeed as a franchisee. It is intended to transform the recruitment journey for franchisors and their franchisee prospects.
Remember it is a two-way process, make sure that you can speak to any franchisees in the network, prepare a detailed business plan, undertake thorough due diligence and find out whether the franchisor is fully accredited with the bfa. All potential franchisees should complete the e-learning initiative (PCF). Finally, don’t be afraid to ask ‘awkward’ questions - after all it is your future and financial wellbeing which is at risk!
FIRST PUBLISHED in FOOD FRANCHISE MAGAZINE (Summer 2017)Wednesday, 7th June, 2017