Buying an existing franchise business

As with the purchase of any business, there is a need to undertake a good deal of background research.   Buying an existing franchise business is different from buying a non-franchised business.

In a many business purchases, shop or office premises will be involved and finance will be required. Therefore, sale agreements will need to be prepared subject to lease approval, lessor consent, and finance consent. With the purchase of a franchise business, the consent of the franchisor is also necessary.

If you find you are becoming serious about a particular franchise business, then it is advisable to establish what that procedure is early in the piece. Not only will the consent of the franchisor be required but, invariably, there will be a need to undergo training, either prior to purchasing the business or soon afterwards. Many franchise agreements contain a clause to the effect that if, during the training, the franchisor decides that the prospective franchisee is unsuitable, then the franchisor may decline accepting the franchisee.

It is therefore important that the business sale and purchase agreement contains suitable clauses to cover the franchise scenario. Most business brokers are experienced with dealing with franchise systems and understand the sort of clauses that need to be inserted into agreements. Some franchise systems have their own clauses which they require to be included in agreements for sale of franchised business.  A worst case scenario would be a purchaser entering into and paying for the purchase of a franchise business, then not being permitted by the franchisor to run the business!

A typical business sale and purchase agreement should include a due diligence clause which runs for a set period of time. It gives the purchaser the opportunity to research the business, find out about the franchise, look at the books and find out what the conditions are in the business.

We recommend that before you sign a sale agreement unconditionally, you meet with the franchisor. That meeting should enable you to find out more about the franchise system as well as establishing whether or not you would be comfortable working under the franchise system or, indeed, under the person who controls the franchise system. Sometimes, franchises are never going to work simply because there is a personality, or business philosophy clash.

Don’t be surprised if the franchisor comes across as somewhat hard and fast in the way they deal with matters. If the system is well-established and is a proven system, then the franchisor is not going to change its ways in dealing with prospective franchisees, and there is a high level of control exerted by any franchisor in a well established system, which should benefit not only the franchisor but all of the franchisees working within the system.

It is important to ask the franchisor about the track record of the franchised business that you are interested in purchasing. In particular, you should ask whether or not there are any disputes or breaches of the franchise agreement. Direct questions like this from you to the franchisor are important and are likely to earn the respect of the franchisor who will see you as a person who is not going into a purchase lightly.

If the franchisor is a member of the Franchise Association of New Zealand Inc, there should be a disclosure document attaching a franchise agreement which should be provided to you at least 14 days before you sign the franchise agreement. That disclosure document is similar to a company prospectus and describes valuable information about the franchisor, the system and the franchise agreement.

It is advisable to make enquiries of existing or previous franchisees within the system. The purpose of doing this is primarily to ensure that those other franchisees are satisfied with the system and with the franchisor. In any system, there is likely to be one or two disgruntled franchisees but if the overwhelming response is favourable then that is a good indication that the system is successful.

Being a member of the Franchise Association of New Zealand, Inc. is also a good indication that the franchisor is committed to high standards and all franchisors as part of that association are required to observe a Code of Practice and a Code of Ethics. Copies of those Codes should be provided to you by the Franchisor 7 days before signing a franchise agreement, but can also be found on the website of the Association.

A prospective purchaser should engage an accountant at an early stage to assist in the due diligence process. That applies to any business but it is important in the case of franchising that the accountant understands what royalties are paid to the franchisor and what other payments apply, such as an advertising levy or a mark-up on products. It is also important to engage a lawyer who understands franchising. The lawyer should be asked to review the sale agreement prior to signing the document, and should be kept informed throughout the due diligence process.   The lawyer should also be given a copy of the franchise agreement at an early stage to review and provide a written summary of that document.

You need to be aware that training periods can vary considerably from system to system. In the case of most franchise systems the training will occur locally but with a few systems brought into New Zealand from offshore, the training can occur either in Australia or the U.S.A. You need to budget for this training, which is usually at the cost of the purchaser, but with some systems, that is paid by the vendor. Again, your accountant needs to know this information so they can assist you in determining whether the purchase of the business is good value for money.

As with the purchase of any business there is a good deal to be done before taking possession of the business. You need to be highly organised and you need to write down notes of conversations with business brokers, the vendor, and the franchisor. These notes can be valuable later on if there are any disputes. Sometimes, it is advisable to confirm conversations in writing, typically by email. It is also important to keep your accountant and lawyer informed as to the progress with the transaction and, particularly, to meet deadlines with dates such as lessor consent, finance approval and franchisor approval.

Franchising is not recommended for people who do not readily accept a fairly heavy level of control in how a business is operated. Franchising is all about working within a system where the franchisee is expected to toe the line and follow the manuals.  Usually, manuals are not made available to the franchisee until the franchise agreement has been signed.   It is important to read the manuals as early as possible and that should all be part of the training process.

There are many franchise systems available in New Zealand. Like any form of business, there is always an element of risk and this can occur through a system ceasing to be competitive or through poor management at the franchisor level.   Do plenty of research before making a decision to purchase.