Due Diligence Checklist for Buying a Franchise Business

Buying a franchise in Australia can leverage an existing and proven business model. You are not starting your business from scratch, but entering one with brand recognition and a loyal customer base. However, purchasing a franchise is similar to other investments in that it comes with inherent risks and no guarantees of success. As a prospective franchisee, you should conduct due diligence before buying the franchise. 

The process involves comprehensively evaluating the franchise opportunity to ensure it aligns with your business goals and investment capacity. You can make informed decisions and mitigate potential risks by reviewing the Franchise Disclosure Document (FDD), analysing financial statements, consulting with current franchisees and getting assistance from a legal professional.

Initial Research and Pre-Qualification

Buying a franchise begins with initial research and pre-qualification. The foundational step ensures the franchise aligns with your interests, financial capabilities, and the market’s potential.

Identifying Your Interests

Aligning your franchise choice with your personal passion and financial capacity is crucial for long-term success. Begin by assessing what industries excite you and where your interests lie. This alignment ensures that you remain motivated and committed to your franchise type of business. 

Additionally, evaluate your financial capacity to invest in the franchise, considering both the initial  fee and ongoing franchise costs such as royalties and marketing fees. Understanding your financial limits helps choosing the right franchise opportunity and one that fits within your budget. In return, this understanding reduces the risk of financial strain down the line.

Conducting Market Research

Thorough market research is essential to understanding the Australian market, competition, customer demographics, and growth potential of a particular franchise. 

Start by analysing the demand for the products or services offered by the franchise in your target area. Investigate existing competitors to identify gaps in the market that your franchise could fill. 

Additionally, study customer demographics to ensure that the franchise’s offerings align with the preferences and needs of the local population. This research will provide valuable insights into the potential profitability and sustainability of the franchise in your chosen location.

Exploring Franchise Directories

Use online franchise directories to compare franchise options across industries. These resources help you evaluate franchises based on brand reputation, investment requirements, and support systems, ensuring alignment with your goals and financial limits.

Requesting the Franchise Disclosure Document (FDD)

The FDD is a crucial resource detailing the franchisor’s obligations, system, and financial information.

1. Express Your Interest: Contact the franchisor officially to request the FDD as a potential franchisee.
2. Complete a Franchise Inquiry Form: Many franchisors require a form with financial and background details to assess your suitability.
3. Sign an Non-Disclosure Agreement (NDA) (if required): You may need to sign a NDA to access sensitive information.
4. Receive the FDD on Time: Franchisors in Australia must provide the FDD at least 14 days before any agreements or financial transactions. Ensure this timeline is met.
5. Confirm Receipt: Verify receiving the FDD through secure channels. Follow up if delays occur.

Analysing the Disclosure Document

Once you receive the FDD, carefully review the following critical elements:

• Franchise Fees and Investments: Assess startup costs, royalty rates, and ongoing obligations.
• Territorial Rights: Ensure exclusive geographical rights to minimise local competition.
• Training and Support: Review promised training programmes, marketing assistance, and operational guidance.
• Historical Performance Metrics: Look for data like average sales figures and profit margins to estimate return on investment.
• Legal Aspects: Study the franchisor’s litigation history, renewal clauses, and dispute resolution procedures.
• Intellectual Property Protection: Verify the validity of trademarks, copyrights, and branding.

Financial Statements Analysis

Analysing financial statements allows you to evaluate the stability and profitability of the franchise system. Focus on the following aspects:

1. Profit and Loss Statements. Review the franchisor’s profit and loss statements to understand revenue streams, cost structures, and profitability. Look for consistent revenue growth and manageable expenses.
   
2. Balance Sheets. Examine the balance sheets to assess the franchisor’s assets, liabilities, and equity. A healthy balance sheet with strong asset management indicates financial stability.
   
3. Cash Flow Projections. Analyse cash flow projections to determine the franchisor’s ability to sustain operations and support you. Positive cash flow forecasts suggest long-term viability.
   
4. Debt and Liabilities. Identify any outstanding debts or liabilities that the franchise owner holds. High debt levels may impact the ongoing support from the franchisor.
   
5. Financial Ratios and Metrics. Calculate key financial ratios, such as gross profit margin, return on investment (ROI), and debt-to-equity ratio. These metrics offer insights into the franchisor’s operational efficiency and financial health.
   
6. Audited Financial Statements. Ensure that a reputable accounting firm audits the financial statements. Audited statements provide a higher level of assurance regarding accuracy and reliability.
   
7. Historical Financial Performance. Assess the franchisor’s historical financial performance over the past three to five years. Consistent growth and profitability trends indicate a robust business model.
   
8. Future Financial Projections. Evaluate the franchisor’s future financial projections and the assumptions underlying these forecasts. Realistic and well-supported projections are indicative of careful planning and market understanding.

Evaluating the Franchise Agreement and Legal Aspects

Before you sign on the dotted line, ensure you understand your rights and obligations.

Legal Consultation

• Engage a franchise lawyer to dissect complex legal jargon, review restrictive clauses, and safeguard your rights.
• Ensure clarity in areas like territory rights, royalty structures, termination clauses, and restrictions.

Intellectual Property Rights

The agreement should clearly define your rights to use the franchisor’s intellectual property, such as trademarks and proprietary systems. Well-secured IP adds operational value and ensures brand consistency.

Contacting Current and Past Franchisees and Assessing Operational Aspects

Reaching Out to Franchisees

Approaching franchisees helps gather valuable first-hand information for your evaluation. To effectively contact franchisees, ask the franchisor for a list of contacts as part of the FDD. 

When reaching out, prepare the right questions to gain insights into their experiences, challenges, and overall satisfaction with the franchise system.

Consider the following guidelines:

• Be Respectful of Their Time: Schedule appointments in advance and keep conversations concise yet thorough.
• Ask Specific Questions: Enquire about the support received from the franchisor, the accuracy of initial financial projections, and any unforeseen obstacles they encountered.
• Listen Actively: Pay attention to both verbal and non-verbal cues. Honest responses will provide a clearer picture of what to expect.

Inquiring About Support and Operations

Prepare key questions to ask the franchisees, focus on the following areas to evaluate the franchisor’s effectiveness:

• Training Programmes: Assess the comprehensiveness and quality of the initial training provided by the franchisor. Ask franchisees how well the training prepared them for running the business.
  
  • Example Question: How would you rate the initial training programme preparing you for day-to-day operations?
• Ongoing Support: Determine the available support, such as marketing assistance, operational guidance, and troubleshooting help. Enquire about the responsiveness of the franchisor when issues arise.
  
  • Example Question: Can you describe the ongoing support you receive from the franchisor and how effectively they address your concerns?
• Operational Challenges: Identify common operational challenges faced by franchisees and how the franchisor assists in overcoming them. Understanding these challenges can help you gauge the robustness of the support system.
  
  • Example Question: What main operational challenges have you encountered, and how has the franchisor helped you address them?
• Franchisee Satisfaction: Gauge overall satisfaction by asking about the franchisor’s commitment to franchisee success and the support systems in place. High levels of satisfaction often indicate a healthy franchisor-franchisee relationship.
  
  • Example Question: On a scale of 1 to 10, how satisfied are you with the support provided?

Assessing Location, Premises, and Compliance

Market Analysis of the Location

Conducting a comprehensive market analysis helps you understand the potential customer base, competition, and overall market dynamics. Key factors to consider include:

• Demographics: Evaluate the local population’s age, income levels, and lifestyle preferences to ensure there is a demand for your franchise’s products or services.
  
• Foot Traffic: Assess the area’s volume of pedestrian and vehicular traffic. High foot traffic can lead to increased visibility and higher sales opportunities.
  
• Competition: Identify existing competitors within the vicinity. Understanding their strengths and weaknesses can help you position your franchise effectively.
  
• Market Trends: Investigate current and emerging market trends to gauge future growth potential. This includes analysing consumer behaviour and industry forecasts.
  
• Accessibility: Ensure the location is easily accessible by public transport and has adequate parking facilities, enhancing customer convenience.

Reviewing Lease Agreements

A thorough review of lease agreements is essential to secure favourable terms and conditions that support running the franchise. Key elements to focus on include:

• Lease Term and Renewal Options: Examine the duration of the lease and the conditions under which it can be renewed. Aligning the lease term with the franchise agreement is crucial to avoid conflicts.
  
• Rent and Additional Costs: Understand the base rent, outgoings, and additional costs, such as maintenance or utilities. Clarify responsibilities for each cost to prevent unexpected financial burdens.
  
• Fit-Out Responsibilities: Determine who is responsible for the cost and execution of fit-outs or renovations. Some franchisors may handle these aspects, while others expect franchisees to manage them.
  
• Lease Assignment and Subleasing: Check if the lease allows for assignment or subleasing, which can be crucial if you transfer the franchise.
  
• Landlord Obligations: Understand the landlord’s responsibilities regarding property maintenance and repairs to ensure a safe and functional environment for your franchise.

Ensuring Legal Compliance

Adhering to legal compliance is fundamental to maintaining the integrity and legality of your franchise operations. This involves adhering to various laws, regulations, and standards set forth by governing bodies. Key compliance areas include:

• Australian Franchising Code of Conduct: Familiarise yourself with the Franchising Code of Conduct, which outlines the franchisors’ and franchisees’ rights and obligations. Compliance with this code is mandatory for all Australian franchises.
  
• Licences and Permits: Verify that all necessary business licences and permits are obtained and maintained. Requirements vary based on the type of franchise and its location, so ensure you are aware of specific regulations.
  
• Health and Safety Standards: Adherence to health and safety regulations ensures a safe environment for employees and customers. This includes regular inspections and adherence to safety protocols.
  
• Employment Laws: Comply with Australian employment laws related to hiring, training, and managing staff. This includes fair wages, working hours, and workplace safety standards.

Financial Considerations and Funding

Calculating Total Investment

It’s important to understand the total investment as it ensures financial readiness and long-term sustainability when looking to buy a franchise. The total investment typically encompasses several key components:

• Initial Franchise Fee: This is the upfront cost of acquiring the rights to operate under the brand. Depending on the franchise’s industry and market position, the fee can range from a few thousand to over a million dollars.
• Start-Up Expenses: These include costs related to setting up the business, such as leasing or purchasing a location, renovating the premises, purchasing equipment, initial inventory, and securing necessary licences and permits.
• Working Capital: It’s essential to have sufficient working capital to cover operational expenses for the first few months until the business becomes profitable. This includes salaries, utilities, marketing, and other day-to-day costs.
• Additional Costs: These may involve insurance, legal fees, training, and other miscellaneous expenses arising during the start-up phase.

Securing Financing

Securing adequate financing is a fundamental step in the franchise acquisition process. Here are the primary financing options available:

• Bank Loans: These require detailed business plans and substantial collateral.
• Franchisor Financing: Many franchises offer in-house financing options or partner with financial institutions to facilitate franchise loans. These arrangements can sometimes feature more favourable terms compared to traditional bank loans.
• Personal Savings and Investments: Utilising personal savings or investments can reduce reliance on external lenders, potentially leading to better interest rates and more flexible repayment terms.
• Alternative Financing Sources: Options like crowdfunding, peer-to-peer lending, or investor partnerships can be explored for additional funding. These sources may offer unique advantages, such as less stringent credit requirements or faster approval processes.

Understanding Ongoing Costs and Royalties

Ongoing fees and royalties are continuous costs that franchisees must account for as part of their business operations. The franchisor typically requires these fees in exchange for ongoing support and the continued right to use the franchise brand and systems. Key aspects include:

• Royalty Fees: These are regular payments, usually calculated as a percentage of the franchise’s gross sales. Royalty fees support the franchisor’s ongoing support, marketing efforts, and system improvements.
• Marketing Fees: Many franchisors require contributors to a collective marketing fund. These funds are used for national or regional advertising campaigns, promotional materials, and other marketing initiatives that benefit the franchise network.
• Technology Fees: In some franchises, especially those relying heavily on proprietary technology or software, there may be additional fees to cover updates, maintenance, and support for these systems.
• Training Fees: Ongoing training and development is often a component of a franchisor’s support system. These fees cover continual education for franchisees and their staff to ensure consistency and adherence to the franchise’s standards.
• Renewal Fees: At the end of the franchise agreement term, renewal fees may be required to continue operating under the franchisor’s brand. These fees can vary and should be factored into long-term financial planning.

Conclusion

Buying a franchise is a significant investment that requires careful consideration and thorough assessment. You can make an informed decision and mitigate potential risks by following a comprehensive franchise checklist that includes researching the franchisor and industry, reviewing financial statements, and contacting current and former franchisees.

To ensure the success of your franchise investment, it is essential to undertake each step diligently and seek professional advice when necessary. Contact our franchise lawyers today to guide you through the due diligence process and help you secure a thriving franchise business.

Frequently Asked Questions (FAQ)