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WHY READING THE FINE PRINT IN A FRANCHISE DISCLOSURE AGREEMENT MATTERS

Deciding to buy a franchise business is a big decision. This makes it essential that you carry out some basic research on the franchisor and carefully review the disclosure document.

Per the Australian Franchise Code of Conduct, franchisors have to provide a disclosure document to all potential franchisees. It presents you with the necessary information on the franchisor, and whether the franchise you’ve chosen is the perfect fit for you.

Information about the franchisor’s history, costs associated with the franchise, mutual expectations, and the structure of the company, existing franchisees, and the fees are all included in the document.

The Importance of a Disclosure Document

The Franchise Code of Conduct has a fixed structure that a franchise document must follow. Its primary objective is to provide franchisees with an unbiased view of the system. This makes it necessary for the franchisor to put all the cards on the table. Transparency is an essential aspect of the disclosure document.

While reading the document, note down the things that you don’t fully understand, and request the franchisor to clarify them. A thorough review of the disclosure document is a vital part of your due diligence.

Here are a few crucial points you should keep in mind while reading through your disclosure document;

1. Business Experience and Details of the Franchisor

This gives you an overall idea of the franchisor’s structure, business experience, and an overview of its managers and directors.

2. Current and Past Franchisees

A disclosure document should also have a detailed list of all current and past franchisees. This presents you with the opportunity to ask franchisees about their experience working with the franchisor. They will provide you with inside information on the workings of the franchise system. A disclosure document should provide you with information on the last three years, including:

• The number of franchises that ceased to operate
• The number of franchise agreements not extended
• How many franchises transferred?
• The number of agreements the franchises or franchisees terminated
• The number of franchises the franchisor brought back into the fold

 
A significant number of franchises for sale (more than 10%), as well as a higher turnover rate, should be taken as a warning sign. This is because a healthy franchise system should have a low turnover.

In case over half of all current franchisees transfer their business, cease to operate, or were bought out by the franchisor, it indicates that the health of the franchise system is not good.

3. The Supply of Products and Services to A Franchisee, By A Franchisee and Online

A disclosure document also states the limit on suppliers a franchisee can utilise. In most cases, a franchisee may only use approved suppliers. It also stipulates information on products and services provided by the franchisor to a franchisee, and restrictions.

As per the disclosure document, the franchisor has to provide detailed information on goods and services that are sold to online customers.

4. Litigation

Cases of bankruptcy/disputes the franchisor is facing, including misconduct, dishonesty, infringement of trade practice laws, as well as fraud and breach of the franchise agreement or the Franchise Code of Conduct, have to be stated.

Besides, the franchisor has to also present information on bankruptcy or insolvency over the past 10 years. It can indicate serious problems, which makes it vital that you review this information thoroughly. Although litigation takes place in many businesses, too many of them is a warning sign.

5. Site and Territory

The disclosure document also states the rights of the franchisee regarding territory. The rules concerning area differ from franchise to franchise. The franchisor must present you with precise information on the region you buy into, and other laws regarding exclusive and non-exclusivity. The document should also specify the information on the territory of the past decade.

This is incredibly important as it helps you understand whether the franchisor or other franchisees can compete in the same territory. However, there are certain restrictions when it comes to competition.

6. Payments And Fees

This is arguably the most crucial aspect for potential franchisees. This section of the document outlines all the costs and fees that are commonly associated with the franchise business. While preparing your financial forecasts, you must take fees and other costs into account, including:

• Financial fees, setup costs, deposit, and training fees.
• Payment when the franchise comes to a close. This is referred to as exit fees or transfer fees.
• Due fees during the term of the agreement. This is referred to as royalty fees, IT levies, fees payable to a third party, or marketing levies.

 
If you want to know more, feel free to get in touch with us at The Franchise Institute. You can call us on 1300 855 435 or fill in this contact us form, and one of our experts will contact you as soon as we can.

Thanks for reading,
The Franchise Institute Team
1300 855 435