What you need to know before buying a franchise

Franchising is a popular way to start and operate a successful small business. According to the business adviser IBISWorld, the market size for franchised outlets in Australia is $172 billion, and more than 94,500 small businesses operate as franchised outlets, employing over 565,000 people.

Franchising is flourishing in businesses ranging from travel, pet supplies, motoring  and home maintenance to bookkeeping, mortgage broking and real estate.

But is franchising the right move for every aspiring SME owner?

Franchising is a category of business operation where the SME owner (called franchisee) pays a fee for the right to offer, sell or distribute goods or services under a business system designed by the business founder (called the franchisor). A franchisor such as McDonald's and 7-Eleven provides leadership, advice, training and other assistance for a fee.

Franchising's advantages extend beyond brand association. As a new owner, you're not entering the industry alone. The franchisor can offer support for recruitment and retention, marketing and the latest technology platforms. Better still, you can share the costs of these services with other franchisees within your group.

An easier transition

Angus Raine is executive chairman of the Raine & Horne property group, a franchisor for more than 45 years. He says aligning a small business with a respected brand that delivers industry-leading support, training  and marketing is a prudent way to transition into a small business.

"The comprehensive training and systems offered by a franchise group can fast-track your business strategy by not just months but by years," he says.

"When you compare joining a franchise to starting an independent small business, whether it's a cafe, mortgage broker or burger joint, it will be so much easier. If it's a proven franchising model, a brand that already has recognition, your chances of success are usually much greater."

An estimated 20% of new small businesses in Australia will fail in their first year, and up to 60% of start-ups will not survive beyond five years.

In comparison, less than 20% of businesses that are part of a franchise network fail in the first five years.

Anne Nalder, founder and CEO of the Small Business Association of Australia, agrees that the advantage of being part of a franchise is that the systems are already in place. "The support from a franchisor includes taking care of marketing and even providing the franchisee with sales leads."

It may also be easier for SMEs to secure finance if they are part of a network.

Buying a franchise requires a fair amount of cash. According to the Franchise Council of Australia, fees (upfront franchise fees and set-up costs) can range from $5000 to $1 million or more. If you're considering buying an Oporto fast food outlet, for example, expect franchise start-up fees to range between $350,000 and $700,000 plus GST.

In addition, the new franchisee must fund shop fitouts, plant and equipment, inventory and lease commitments.

As well as start-up costs, franchisees pay ongoing costs to the franchisor, including royalty fees. According to broker.com.au, royalties are often calculated as a function of sales, typically 5%-6%, but they can be as high as 15%. Some franchisors charge a fixed fee irrespective of sales levels.

There might be restrictions about where you operate, the products you sell and the suppliers you use. There will typically be marketing and brand guidelines that might not work for more creatively-minded entrepreneurs.

Separate costs, such as marketing fees, may also apply. As fees are a leading source of dispute between franchisors and franchisees, it is critical to understand precisely what your initial and ongoing costs will be before buying a franchise.

Seek expert advice

As with any relationship involving money, there's always the chance that things get wobbly between franchisees and the franchisor.

"Before signing on the dotted line, obtain legal advice as to the terms and conditions of the contract," advises Nalder. "The contract needs to include the terms of exit.

"If the franchisee does not obtain legal advice or does not understand the terms and conditions of the contract and problems arise, the franchisee will have no legal leg to stand on as courts are interested in what the contract states."

It is important to carefully consider all your options before buying a franchise and to seek advice from an experienced business adviser, accountant or lawyer.

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