Buying a franchise

13 November 2007
Page 1 of 7 : single page

A franchise is a business arrangement in which the knowledge, expertise and often the trade mark or trade name of a business are licensed to another operator. Usually the franchise business is run along the lines agreed to between the parties and some of the terms that are used in such arrangements include "licence", "exclusive distributorship" and "dealership".

What is a franchise?

Most franchises have strict controls on such things as buying and advertising as well as the buying of any stock from anywhere except from the owners of the franchise. Controls may also apply to quality control, bookkeeping and other areas of the business operations. The "franchisor" is the seller of the franchise and the "franchisee" is the buyer.

Franchising is one of the fastest growing business sectors. A franchise is a contract, agreement or arrangement between two or more parties in which one or more of the following obligations exist:

The right to use a trademark or trade name.
The expectation that prescribed marketing business or technical plans and systems will be followed.
Marketing business or technical assistance during the operation of an agreement.

A franchise can therefore involve:

A product - Where the franchisee acts as a wholesaler or retailer (e.g. As in motor vehicle and petrol business).
A System - Where the franchisor permits the franchisee to use a unique Method of doing business (e.g in fast food outlets, motels etc)
A Manufacturing arrangement - Where the franchisor provides an essential ingredient or know-how (e.g. In the soft drink industry).

A franchise usually takes the form of:

A business format franchise in which the whole business concept is licensed including the name, appearance and method of carrying on the business, or
A product franchise in which the product is manufactured and/or supplied by the franchisor as occurs in the retail, fuel and motor vehicle industries.

Advantages And Disadvantages For The "Buyer"

Advantages include:

The buyer is able to get access to products or services without having to spend the time and money to develop the business on their own. He/she is able to tap into the already established operation and if it is a successful business then he or she can be confident that some of that success will benefit.
The buyer of the franchise also gets the advantage of lower cost through bulk buying from suppliers and through the pooling of advertising.
The buyer of the franchise gets the benefit of the past experience of the business management and assistance in other areas such as quality control business systems, location choice etc are available.
The buyer of the franchise is usually able to obtain assistance from the seller with the start up costs making it possible to enter a bigger business than what could be normally afforded.

Disadvantages include:

The terms of the franchise agreement may be so tight that the franchisee is unable to achieve the required return on the investment.
Often assistance that has been promised by the franchisor does not materialise.
There are far more controls under a franchise arrangement because the terms of the agreement will usually have a say in what is bought, the location of the business, what price is charged, how the business is to be run etc.
Sometimes the buyer does not receive the capital gain or goodwill from the business, which the buyer has developed, and some franchisors are quite ruthless and able to terminate the agreement for minor reasons. This threat of termination often puts the franchisee in a situation where he or she has to accept decisions that are sometimes to his or her disadvantage.
The lack of independence in operating the business leads some franchisees to complain that they are really no better off than working for a boss except that when working for a boss there are at least benefits and security enjoyed as an employee.
Sometimes because of the professional way the franchise arrangement is presented, the business appears a lot more profitable than in fact it would be. Often the buyer of a franchise is put into a false situation feeling they are able to make quick profits with little work.

Evaluate a franchise closely

Businesses can and do make good profits under franchise arrangements. Many small business owners have been helped in getting a sound start by investing in a franchise. But a franchise costs money. Although one can be purchased for as little as a few hundred dollars, most involve a considerable sum of money and so it is vital that you investigate and evaluate carefully any franchise before you invest.

Although most franchises are managed by reputable business people one should always keep in mind that some may be poorly managed and financially weak.

There are also business operations that adopt questionable practices and ensure for example, that the controls and restrictions in the agreement are one sided in their favour. Whatever the type of franchise, the arrangements between the parties and the provisions of the agreement, are vital and these should be thoroughly investigated and assessed by a suitably qualified person, preferably your lawyer. To help you assess a franchise we have included here a franchise checklist which outlines some of the questions you should ask yourself before making a commitment.

Initial Questions To Ask Yourself

Before making your buy decision, here are a few quick test questions that you can ask yourself and perhaps save a lot of time, money and headaches.

Were you promised high profits in exchange for minimum effort?
Did the representative pressure you to sign a contract immediately?
Were you told that this was your last chance to sign and that if you did not, the opportunity would be lost?
Was the representative clear and open in answering questions that you put to them specifically?
Did the representative give you a responsible list of references as well as other operators that you could have discussions with?
Did you feel that the representative was more interested in selling the franchise rather than ensuring that you would be successful in business?
Did the representative try to discourage you from having your lawyers review fully the agreements and other arrangements before signing?
Have you been able to visit one of the franchises already operating and discuss with the owner of that business matters to do with the franchisor's reputation and conduct, and obtained information about the company itself and how it is managed?

If the answers to these questions are no then you will probably be able to proceed to the next step, which is the checklist of your evaluation programme.

If any of these questions are answered with a yes you may have to think further or take that matter up with the representative.

Checking out a franchise

For many people investment in a franchise represents a commitment of all their financial resources. Buying a franchise, therefore, should not be taken lightly. We cannot stress enough that independent professional advice about the proposal is critical. Talk to your adviser first.