InvestSMART

Do the numbers stack up?

People thinking about buying a franchise would be wise to do their own due diligence.

People thinking about buying a franchise would be wise to do their own due diligence.

Buying into a franchise network might seem like a good use of money such as a redundancy payout, inheritance or even a retirement nest egg. However, the sector has been criticised - unfairly, the franchising industry says - by the competition regulator.

The chairman of the Australian Competition and Consumer Commission, Rod Sims, says he is concerned about "rogue elements" and the potential power imbalance between franchisors (who run the networks) and franchisees (who buy the individual businesses).

He warned the recent Franchise Council of Australia national convention that the ACCC, which receives 600 complaints a year, would do more to enforce the industry code of conduct.

However, the franchise council considers his concerns to be overstated, pointing to a Griffith University study that found less than 1 per cent of franchise operators were in dispute with their franchisor.

The council's executive director, Steve Wright, says only about 50 of the 600 complaints a year result in action being taken and the level of complaint has to be put in the context of 1200 networks with 70,000 franchisees and a turnover of $128 billion a year.

THE PITFALLS

Sims told the convention that franchising had strengths but many pitfalls. He said he had personally observed "both the early promise and, in some cases, the unfortunate reality" of buying a franchise.

He said franchisors "are often large and well-resourced companies that hold substantial power in the franchising relationship. They co-ordinate the operators, they own the brand and, in many cases, they control the supply of the key products for the franchising business.

"On the other side, franchisees are often couples or individuals, many of whom enter the franchising relationship without a great deal of business experience but nevertheless invest large sums of money - and sometimes their nest egg ... without doing sufficient due-diligence checks."

That's one thing on which the ACCC and the franchise council agree: potential franchisees should make sure they do their homework before paying between $5000 and $1 million in upfront franchise fees and handing over between 2 per cent and 15 per cent of their turnover.

DON'T ACCEPT CLAIMS

Wright says people must look behind "headline" figures and beyond the first franchise system that catches their eye to make sure they're putting their money into something that will survive and be profitable.

"Don't just accept claims at face value there may be more information you need to get the full picture," he says.

Sims told the convention: "One important area where we could do more is in relation to the information provided to franchisees in relation to their likely earnings.

We can perhaps look more closely to see where franchisees have been misled ... improvements in this area alone would greatly improve the reputation of franchising."

Wright says people also must make sure franchising is a good match with their personality type and lifestyle.

Complaints to the ACCC sometimes come from independent-minded people who struggle with the regimentation of a franchise network's system, he says, which requires them to run their business a certain way.

"If everybody was able to do what they wanted to do, you'd have no system," he says. "But some people like greater freedom and feel frustrated at not having it.

"If you're a maverick, franchising is not for you."

SUCCESS RATES

If the franchise you're looking at is a good match for you and stacks up as a solid business, the next step is to take advantage of pre-entry education opportunities, Wright says.

Go to expos and seminars and tap into resources such as the online training offered by the Griffith University-based Asia-Pacific Centre for Franchising Excellence (franchise.edu.au/pre-entry-franchise-education).

The bottom line is that franchises have a proven record, Wright says.

Australian Bureau of Statistics figures show that 40 per cent to 45 per cent of small businesses close within the first two to three years, with failures rising to 60 per cent to 70 per cent after three to four years. Yet the average term of a franchise contract is five years and the average tenure in a network is seven years, so franchisees generally experience sufficient success during their initial contract to want to keep going.

GREATER PROTECTION

Also, a PricewaterhouseCoopers study of the 200 leading networks during the past two financial years found that both franchisors and franchisees achieved double-digit revenue growth and similar growth in profitability at a time when the small-business sector in general was hurting, he says. "That's the most potent sign of business success."

Sims says the ACCC will audit franchisors regularly under new powers that came into effect this year, which allow franchisees to anonymously report problems to the commission if they fear retaliation from franchisors.

Key points

- The ACCC is concerned about dubious practices in franchising.

- It will conduct regular audits under new powers that came into effect this year.

- It is targeting, in particular, misleading claims from franchisors about likely earnings.

- Buying into a franchise can cost up to $1 million.

- Franchisors also take a cut of ongoing turnover.

- Franchises do tend to be more successful than the average small business.

Good preparation is an essential ingredient

- Assess your reasons for wanting to own a business.

- Assess the lifestyle and income implications of your choice.

- Read the Franchise Guide (available at franchise.org.au).

- Narrow your search to a few systems, then request more information.

- Ensure you have adequate borrowing capacity, including working capital.

- Be sure you receive and evaluate all compulsory disclosure material.

- Ensure you get legal and accounting advice from advisers with relevant experience.

- Use the cooling-off period to review your decision.

Source: Franchise Council of Australia


Join the Conversation...

There are comments posted so far.

If you'd like to join this conversation, please login or sign up here

Related Articles