What to expect and do when buying a franchise.
Franchising in South Africa has in recent years become a preferred investment for entrepreneurs and financing institutions with franchising contributing around 12,5% towards South Africa’s GDP, nonetheless, as with any investment the key is to know what you are getting yourself into. More often than not, buying a business is an emotional and overwhelming experience, especially for first time buyers due to the fact that they do not know what to expect, what questions to ask or what aspects to focus on to make an informed decision. The following tips might assist in making the decision somewhat easier for potential franchisee’s.
THE INITIAL PROCESS
After getting in touch with a franchisor and requesting the franchisor to provide you with more information on the franchise business, one of three things will probably happen: a.) the franchisor will send you an application form requesting certain information to assess you and see whether you are a suitable candidate to become a franchisee, b.) invite you to attend an interview to discuss your suitability and provide you some information on the franchise or c.) send you a Non-Disclosure and Confidentiality Agreement (“NDA”) to sign and send back, after which the franchisor will provide you with more information.
Regardless of the initial vetting process, at some point the franchisor must provide you with a written disclosure agreement, which must be done at least 10 days prior to signing the franchise agreement as required by the Consumer Protection Act, 2008 (“CPA”). In my view – signing a franchise agreement 10 days after receiving the disclosure agreement does not allow you sufficient time to properly assess the investment opportunity.
In some instances, a franchisor may request you to pay a deposit before initiating discussions or assessments of applicants, this is permitted as long as it is a refundable deposit. Whenever a deposit is payable, you should insist that the amount is deposited into the franchisors attorneys’ trust account and that specific written guidelines be given to you on how the deposit will be administered regarding the allocation and recovery of costs, fees and/or disbursements incurred by the franchisor, if any, during the application and discussion phase.
THE DISCLOSURE AGREEMENT
Every franchisor, whether a member of the Franchise Association of South Africa (“FASA”) or not, must provide prospective franchisees with a disclosure agreement containing the information as specified by the CPA. In the disclosure agreement you will find a whole array of information, for me the most prominent information is that of the franchisors experience, other business interests of the franchisor and the franchisors financial position, the financial projections of a franchise business, the material terms and conditions of the franchise agreement, details on the current franchisee’s and probably most significantly, details of those franchisees whom seized being a franchisee within the last three years.
The disclosure agreement is probably one of the most significant documents in assessing the franchise business and most importantly the character of the franchisor. Remember, you are looking to enter into a business relationship with someone (in this case the franchisor) whom you do not really know and it is absolutely in your best interest to investigate that person to fully satisfy yourself that your business relationship will be one that is acceptable and compatible with you.
Assessing the franchise business and the franchisor, how do I do that? It’s simple, you speak to existing and former franchisee’s, visit franchise outlets to experience first-hand how the business operates and chat to the managers about the processes, the franchise business, the support provided by the franchisor and the franchisor ‘store-visits’.
Arguably, the most valuable information you will gather is that from ex-franchisee’s, contact them (the more the better) and discuss the reasons why they are no longer a franchisee, ask them about the good and the bad, however, the information received must never be considered in isolation as that would undoubtedly be unreliable and somewhat untrustworthy, remember, there is always two sides to a story. The information received, consider that as a whole and that should be a good indication of what to expect from the business relationship.
Franchisors have different approaches and processes when approving franchisees and by this stage you might already have had a meeting or two with the Franchisor, nonetheless, at this point you should be in possession of a copy of the franchise agreement. Once you have read through the agreement and assessed the franchise business, you should request another meeting with the franchisor to address any concerns or questions you may have.
During this meeting you should, if you have not done so before, get clarity on what the purchase price includes, obtain a comprehensive list of assets to be supplied, initial working capital requirement, calculation of on-going royalty and advertising fees.
Focus on possible contentious issues or clauses contained in the franchise agreement, these may include aspects such as exclusivity, territory, transferability of the franchise business, right of first refusal, restraint of trade, termination and consequences thereof, the right to renew the franchise agreement and possibly liquidated damages.
Remember, you are entitled to request written explanations from the franchisor on any aspect of the disclosure agreement and franchise agreement. It is wise to do so!
THE SITE VISIT
Location for a business is extremely important, some franchisors will have pre-selected sites available and others will require or allow you to secure your own site to conduct business from, provided that the site meets certain criteria. Whichever the case, you should look at the feasibility of the location by establishing whether the feet and traffic passing through the area is truly your target market.
More often than not, the premises will require some work and alterations to get it in line with the franchisors specifications. Find out from the franchisor whether the costs associated therewith is included in the purchase price or in addition thereto in order for you to assess whether your budget is sufficient for that particular franchise. In some cases, the landlord will be amenable to attend to the necessary work and alterations and amortize the costs thereof to your rent, which is not always ideal.
THE FRANCHISE AGREEMENT AND LEASE AGREEMENT
Do not sign any agreement before you have done a proper viability study on the business, have taken the necessary measures to acquaint yourself with the type of business relationship you will likely have with the franchisor and until you can accept the terms and conditions of the agreements.
Do not underestimate the significance of negotiating the best possible lease and franchise terms, as those two agreements will, for the duration of the agreements and thereafter, dictate to you what you may and may not do, what your rights and obligations will be, what your liability towards the landlord and franchisor will be and theirs towards you and ultimately what your exposure will be should certain events become unavoidable.
Remember this, whenever there is a contract involved, the general principle is – if it’s not in writing and included in the signed agreement, it’s will not be relevant to your business relationship nor will it be of aid to you at a later stage. Thus, make sure to include all undertakings, concessions, representations or commitments made by the landlord or franchisor in the agreement, especially those that led to or induced you to ultimately enter into the agreement. Where written explanations of certain terms and condition have been given, insist that those explanations be included in the agreement as an addendum.
THE FRANCHISOR-FRANCHISEE RELATIONSHIP
After you have signed the franchise agreement, you may cancel the franchise agreement within 10 business days without penalty or liability in terms of the CPA, thereafter the franchise relationship will begin and you will be bound by the terms and conditions of the franchise agreement. In most cases you will be subject to the franchisors control and authority as far as standards, quality, operating hours, dress code, etc. goes and for that reason, before considering to purchase a franchise business you must be satisfied with the fact that you will not be entirely permitted to do your ‘own thing’. After all, a franchisor has a brand, standard and reputation to uphold.
Purchasing a franchise business is different from franchise to franchise as each situation is unique and should be dealt with on a case by case basis. The information contained herein is merely a brief overview of what to expect when purchasing a franchise business and some aspects to place emphasis on and must not be considered as legal advice specifically pertaining to your business dealings.
Purchasing a franchise is a huge undertaking and financial commitment, one that is most likely to change your life, hence, it is advisable to consult an attorney or industry expert to assist and guide you through the process to ensure that you know what to expect, what to ask and ultimately to protect you as best possible.
Written by Dewald Terblanche
Director at Terblanche Attorneys