Detailed Franchise Buying Guide
From our experience acting solely for franchisees, we consider the seven most common and costly mistakes franchisees make to be as follows:
Not choosing a good business concept
Obvious questions to consider are as follows:
- Is this a good business idea?
- Is the product/service likely to be competitively priced?
- How will I generate customers?
The newer the franchise, the more you will need to consider these issues.
Example from our experience: a failed business idea we have come across was for pet boarding (not involving cats or dogs). This franchise was disbanded within a year.
We are aware of difficulties with businesses where the franchisor is obliged to provide leads and the majority of these leads are incapable of being converted into business.
Not doing market research in your potential territory
If you have established the business concept works, you need to decide whether you are likely to be able to sell the product/service in your potential territory.
You should consider:
- What sort of people live in your territory.
- Whether there is already too much competition for similar products in your territory.
Do not presume the franchisor will have done the groundwork on your behalf.
Example from our experience: we had a client who bought a franchise to sell vending machines in pubs. After he bought the franchise, he went to all the pubs in his territory and found the vast majority already had vending machines and were committed to contracts with competing companies. His franchise business failed and he lost over £10,000.
Not checking the track record of the franchisor
Many franchisees forget the importance of checking the franchisor’s trading history. It is only when they come up against problems with the franchise that they start to look into the history of the company and its directors.
This information is available from public sources such as Companies House. Remember: you will have to work alongside those who own and work for the franchise, so it is important to ensure you will have a good working relationship with them. Essentially, you need to know who you are going into business with. However, bear in mind that the shareholders in companies can change, and the people who sell you the franchise may at some stage not be part of the franchise.
In addition, find out about the franchise business (in writing if possible). Ask:
- How long the franchise business has operated for?
- How many franchisees there are?
- How many franchises have failed and why?
- How many franchisees have sold on their franchises?
Although it is good to have this information, some franchisors will not provide it and this should ring alarm bells. Every business has some failures - the franchisor should be honest about this and try to point out why in a particular case the business did not work.
Example from our experience: we recently acted for a potential franchisee who was interested in taking a franchise costing £15,000. The franchisor’s website, which sought to attract franchisees, indicated the business had been successful for over 10 years. However, with some limited research we discovered that a company of a similar name had been wound up with debts in the region of £200,000 and that the franchisor was in fact a company set up less than a year previously and operated by the same directors. Our client decided, on our advice, not to take the franchise.
Not speaking to existing franchisees
One of the most important parts of your due diligence exercise when buying a franchise is to check what other franchisees have to say about the franchise. A ‘good’ franchisor will provide a full list of the names, areas and telephone numbers or email addresses for all (or the vast majority) of its franchisees for you to contact. You should be able to pick whom you speak to.
You should be particularly wary when a franchisor offers you a small selection of people to talk to. These may be hand-picked franchisees who the franchisor can be certain will give you only the most positive information. These franchisees may be given commission or gifts when a new franchisee joins the network.
You should always ask existing franchisees:
- How the business model works.
- How helpful the franchisor is.
- What support they get.
- What training they have.
- If they are finding the business lucrative or not.
- What problems they have encountered and how these have been resolved.
- How they get on with the various franchisor team members.
Example from our experience: we acted for a number of franchisees from the same franchise who were all given the same franchisee to speak to before they purchased a franchise. The franchisee they spoke to had close links with the directors of the franchisor. They were given very positive feedback that was not correct in practice. They all lost at least £30,000 when their businesses failed.
Not reading the manual
Manuals come in various shapes and sizes. We have seen manuals comprising anything from two pages to 10 lever arch files. They generally contain details of the operational requirements for running the business.
Many franchisors will not allow a prospective franchisee to see the manual before signing the agreement, as they claim it contains their trade secrets. However, you must be aware that franchise agreements generally incorporate the terms of the manual into the overall agreement. Therefore, whatever is contained in the manual is as contractually binding as if it were in the franchise agreement itself.
If you do not see the manual before signing up to the agreement, you will be agreeing to be bound by the contents of something you have not even read. There are a few potential ways to deal with this:
- Ask the franchisor if you can visit its offices and read the manual, in a room on your own with no pen or paper, just to check its contents.
- Ask the franchisor to confirm in writing the manual does not contain any obligations that may affect your decision to enter into the franchise, such as who you can purchase from, additional fees, fee increases or terms and conditions upon which you or your customers must operate. If it does contain any of the above information, ask for copies of the relevant pages only.
Example from our experience: a client of ours, who paid £35,000 for a business, was not permitted to read the manual prior to entering the franchise. Once a copy of the manual was received (by which time he was contractually bound), he found the method was out of date and that the terms and conditions he had to use to sign up his clients were so onerous and the fees so high that potential clients refused to sign up for the service and he was unable to get any work. He has since left the franchise and lost the money he invested.
Not understanding the full legal implications
There is no substitute for having your franchise agreement checked by a solicitor specialising in franchising. However, here are some common misconceptions:
- I have paid my initial fee and changed my mind - the franchisor has to give me my money back. This is not correct. Usually, the franchise agreement will state that, upon payment, the initial fee is deemed to have been earned by the franchisor. There is no cooling-off period.
- If the projections I am given turn out to be wrong, I can get my initial fee back. Again, this is unlikely to be the case. There is some protection against misrepresentation, but this is a complex legal area and is often very difficult and costly to prove.
- I have put the franchise in the name of a company, so if it goes wrong I can just wind the company up. This is usually not the case, as in most cases you will have personally guaranteed the obligations of your company.
- If I make no money I can just walk away. This is unlikely to be the case. You have, in all likelihood, signed up to a five-year term with no right to terminate. Accordingly, you will be in breach of the agreement if you stop the business, and the franchisor will be able to sue you for damages.
- At the end of five years if I do not want to renew I can take my clients with me. This is unlikely to be correct. Generally, franchise agreements contain restrictions on what you can do when the agreement comes to an end. This will limit your involvement for a certain period of time in any competing or similar business and will provide for the return of all clients and their details to the franchisor. There is also likely to be a non-solicitation clause that will preclude you from soliciting your clients.
Not taking legal advice
No matter how much homework you do, you should still have a solicitor look over your proposed agreement and talk to them about what you have been told and what you expect from the franchise.
A franchise solicitor will be able to advise you fully on the terms and often what, if any, experience they have had of that franchisor, or market sector, previously. They will also be able to help with any investigations or amendments and side letters to the agreement.
This article is not intended to be a complete legal guide. You should always seek legal advice before purchasing a franchise, and raise any particular concerns you have with a solicitor experienced in franchising.
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