It really pays for franchisees to do their due diligence – here’s how

Breaches of labour standards at 7-Eleven stores, such as underpayment of staff have damaged the brand. Reuters/Samsul Said

We love the brand and we are willing to invest our life savings in it. After all, this is a well known franchise with hundreds of stores so it must be good. The franchisor says it is offering a proven business. It has given us a disclosure document containing many pages of information and we have tried to read the franchise agreement. There is also a lease. To be honest, we can’t really understand all the legal jargon. We just want to get started on running the business. Besides, won’t the Franchising Code of Conduct protect us?

Why the need for due diligence?

These are the views of many naive investors. Potential franchisees need to know what they are committing to before they decide to buy a franchise. This homework is known as due diligence. It is the process of ensuring that investors get what they think they are buying - and that what they buy is actually worth what they pay. You wouldn’t buy a car before taking it for a test drive, having it checked by a mechanic and making sure there was no money owing on it.

Franchisees should take a franchise purchase even more seriously, for two reasons. First, a franchised business is likely to cost much more than a car. Second, unlike when you buy a car, there are no consumer warranties when you buy a franchise. Franchisees must take responsibility for their own investment decisions.

The Disclosure Document will tell a prospective franchisee about who the franchisor is and will provide copious information about the actual business the franchisee will be running. Most franchisors operate within a group of companies. The Disclosure Document will not provide information about most others in the group. Who owns them? Have the directors and all of the companies in the group got a good credit rating? Do they own the companies that the franchisee will have to rely on? Might this influence them?

It’s OK to rely on friends and family to tell you your new haircut looks great, but buying a franchise is a big step. When you are considering such an expensive commitment it is time to visit a lawyer and an accountant who really understand franchising. As franchisees and franchisors have very different interests you’ll need to make sure your advisers have experience in advising franchisees.

Time spent in reconnaissance is seldom wasted

You can do a lot of homework yourself by googling the brand, the industry (to study trends), and the franchisor themselves. You should check out regulators’ websites. You can find out from the ACCC’s site whether the franchisor has the regulator’s permission to require you to buy from specific suppliers.

The ACCC investigates breaches of the Franchising Code of Conduct and publishes information about these investigations. The ACCC does not investigate breaches of franchise agreements so you could search on austlii to find out whether the franchisor has had any court battles. Disputes that are still in progress may not appear in austlii so it pays to also dig around in blogs or online media. And, remember that most Australian franchise disputes are resolved through confidential mediation so you will not find anything published about them.

You can find out a lot about the trade marks and patents the franchisor will require you to use by searching IPAustralia.

By entering the name of the franchisor and each of its directors on the ASIC website you can find out about their corporate activities. Even though it costs a bit you should also do a credit check on the franchisor. A credit check will give you a very good picture of your franchisor’s and their directors’ attitude to paying bills on time.

There are blogs such as bluemaumau where you can ask questions and, of course, you should visit existing franchisees. Don’t just call them - actually visit them at work to see what the vibe is in their business. Remember an existing franchisee might be bound not to say anything about a dispute they have had with the franchisor. They might have signed a confidentiality agreement at the end of a mediation. Don’t just passively accept everything you are told.

You can educate yourself by visiting the ACCC’s site and searching under ‘franchise’. The ACCC has funded an online pre-entry franchise education program run by Griffith University. This will help you decide whether franchising is for you.

Don’t rely totally on any one source of information. Remember, there is always going to be another franchise opportunity so if you are not completely happy, do not rush into buying. Franchisors want satisfied and successful franchisees just as much as you want to be happy and run a profitable franchise.

Demonstrate dispassionate interest

Research has revealed that potential franchisees are often complacent about conducting proper due diligence. Many do not devote enough time or are unwilling to pay for expert advice. Their emotional attachment to the brand often overrides objective information. To undertake effective due diligence a prospective franchisee needs to keep an open mind and to seek out and dispassionately question all information.

This is part of a series on franchising. Read more here.