There are three things that the owner of a franchised business has to give to every new franchisee: a prior disclosure document, a franchise agreement and a copy of the Franchising Code of Conduct. The third one is easy, but the first two may pose some problems for those not familiar with the world of franchising in Australia.
Is your business franchisable?
The first thing to do when drawing up the details of a franchise is to take a close look at your business model. The core elements of the business – sales processes, distribution systems, branding – need to be reduced to their simplest forms so that franchisees can reproduce them easily.
“You must have a seamless process that can be replicated around the world, ideally, but certainly within Australia, for the franchise to work,” says Steven Brown, chairman of Etienne Lawyers. “Can they have a system in place that everyone can follow, so that if a customer walked into a store in Perth, they’d get the same experience as they would in Sydney, New York or Kuala Lumpur?”
It’s a common misconception that franchising is a quick and easy way to make more money out of an already successful business.
“The franchisor needs to work out that they’re going into business for a long time,” continues Brown. “The real value in the franchise system is in that long-term royalty revenue stream, not just in the up-front fees.”
Phil Blain, principle of franchising at BDC, shares this perspective.
“Too often we find that people just decide to franchise a business because they see the opportunity of maybe selling 50 franchises at $50,000 and disappearing into the sunset,” he says. “This is completely the wrong reason to franchise a business.”
Most importantly, businesses shouldn’t rush into the process of creating a franchise without having considered how such an endeavour will operate in the long term.
“Quite often somebody comes along and decides they would like to be a franchisee, and the business is reactive rather than pro-active,” says Blain. “So they rush into some sort of quick arrangement without really thinking through how they’re actually going to support their franchisee and precisely what they’re going to do for that franchisee.”
Get a solicitor
It’s best to seek out the advice of both a franchise advisor and solicitor before turning your attention to any of the documents involved in planning a franchise.
“Definitely have a solicitor do this,” says Blain. “Do not try and download stuff from the web or copy somebody else’s and substitute your business name for theirs. I see it all the time.”
Hiring a franchise consultant isn’t necessarily a sure-fire way of avoiding such situations, either. Blain relates an incident in which a customer approached him to review a franchise agreement that had been put together by a consultant from another company.
Upon reading the document, Blain concluded that it had been poorly adapted from an agreement that appeared to have been written for a business in the oil industry.
“I sent a few clauses off to some of the oil companies, and one of them came back and said that it was their document. There are sharks out there that will do that sort of stuff.”
Under the Franchising Code of Conduct (part of the Competition and Consumer Act, previously known as the Trade Practices Act), franchisors are required by law to issue each franchisee with a disclosure document, a franchise agreement, and a copy of the code itself 14 days before they are required to sign.
The purpose of a prior disclosure document is twofold. Firstly, it has to provide the franchisee with enough information to help them make a reasonably informed decision about the franchise. Secondly, it has to outline the information that is required for the business to run as a part of the franchise.
“The prior disclosure statement sets out a whole raft of information,” says Etienne Lawyers’ Brown. “Who the franchisor is, who the directors are, how long have they been in business, what they are going to do, whether there any court cases that the franchisor has, and who the franchisees are.”
The requirements for the disclosure of information to franchisees are so rigidly set out in the Code of Conduct that the disclosure document even has to mimic the exact ordering and numbering set out in the Code.
“It’s very prescriptive,” says BDC’s Blain. “It says who the agreement is between, who the key people are in the business, who owns the intellectual property. Basically the disclosure could be described as a bit of a summary of the deal.”
One important feature of the document – and one probably dreaded by less reputable franchisors – is that it needs to include the details of all existing franchisees.
“That way, any enquirer can ring any of the existing franchisees and find out what it’s really like in the jungle,” says Blain.
“The other thing that’s of course really important in the disclosure is the list of all the costs that the potential franchisee may expect to encounter, both in setting up the business and in running the business.”
The franchise agreement contains the full details of the franchisor’s commitments to individual franchisees, and vice versa.
“The franchise agreement lays out in layman’s terms how everything is to be done; what fees are to be paid, when they’re to be paid, who they’re to be paid to, how to deal with suppliers, what sort of reporting is required, what sort of meetings they’re going to have, and what happens if they breach the agreement,” says Blain.
“A franchise agreement is like any form of contract,” says Brown. “In it’s simplest form, it’s a checklist of who’s to do what, when it’s to be done and how it’s to be done.”
It’s this document that outlines exactly what the franchisor is going to do for the franchisee, whether that means allowing the use of a trademark, providing goods and services, disclosing how the business’s systems work, or all of the above.
“For example, the McDonald’s franchisor arranges all the raw materials for food products that are to be sold to the franchisee,” says Brown. “So the franchisee doesn’t have to go out and source raw materials.”
In turn, the agreement sets out what the franchisee is going to do for the franchisor. Details about rent, publicity and marketing, and good will to the franchisor’s trademark are common features of a franchise agreement.
“The franchise will have to maintain a working system, and pay a royalty for having a right to have the system and the trademark,” says Brown. “It’ll often also have to pay an advertising fee at a regional and sometimes national level.”
A franchise agreement will also outline the grittier details of the relationship. For example, what happens when a franchisee has to be terminated?
“There are quite often extensive termination features,” says BDC’s Blain. “It depends on the severity of the breach, as to whether that can be rectified, or whether it justifies immediate termination and the franchisee losing the business.”
The sale of a franchise also has the potential to throw a spanner in the works, and the agreement should outline the associated procedures, just in case.
“Typically, the franchisee will be obligated to offer the business back to the franchisor, [which is known as the] first right of refusal,” says Blain. “If the franchisor says no, then they can go to the open market. The incoming franchisee needs to go through the same approval process that the outgoing one went through when they first joined.”
Regardless, a franchisor has the power to knock back a sale, and sometimes does.
“They’ve got to have legitimate cause,” says Blain. “It is a very difficult situation when a franchisee wants to sell their business and has a buyer, and the franchisor doesn’t accept them.”
Intellectual Property License Agreement
According to Blain, another document called the Intellectual Property License Agreement, is also worth investigating, both for prospective franchisees and franchisors.
“It sits between the owner of the intellectual property (IP) and the company that actually contracts with the franchisee,” says Blain.
The document is important, as it will show whether the franchisor has the right to use the franchise’s IP, even if they don’t technically own it.
“Typically, the company that is actually the franchisor is not the company that owns the IP,” he explains.
Often there will be two companies at the core of a franchising business. The first owns the rights to the business’s IP. This company has a licensing agreement with a separate company that deals with franchisees. This arrangement exists to protect the IP, and therefore the rest of the franchisor’s business, should it be sued be a franchisee.
Provided the business is suited to franchising, has a unique selling proposition and has sought professional guidance from a solicitor and franchising consultant, the process of writing a prior disclosure statement and franchise agreement will be relatively straightforward.
BDC’s Blain believes the only real mistake a business owner can make when translating their business into a franchise is to try to do it themselves.
“They really should engage a solicitor to do this, and they should further engage a solicitor that practices in a franchising arena,” he says. “You don’t want to go to your local solicitor that does conveyancing to write a franchising agreement. I’ve seen that done, and it’s a nightmare.”
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