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Franchises – is the Franchise Agreement or Business Model to blame in the event of insolvency?

Franchises – is the Franchise Agreement or Business Model to blame in the event of insolvency?

There are now over 1,000 franchisor businesses and 79,000 franchisee businesses in Australia generating $150 billion revenue, $12 billion worth of profit and employing 450,000 people. Franchising contributes 13% to Australia’s GDP. These are significant numbers for the Australian economy.

Franchises have however, been in the spotlight and not for the right reasons. Several high profile franchisees have recently been placed into an insolvency administration including Max Brenner, Bondi Pizza, Snap Fitness and Toys R’ Us just to name a few. Several failed franchisees have been scrutinised for failing to pay employees the appropriate employee award rates whereby business owners claiming that the franchisor did not provide sufficient training and/or the business model was established in such a way that the business could not succeed.

Like any investment, a potential franchisee should exercise thorough due diligence prior to entering into a franchise agreement and particular consideration regarding the following:

1. Understanding the fine print: franchise agreements can be complicated and may include clauses that provide for royalties, marketing fees and upfront costs to the franchisor. Often the terms of the franchise agreements can be the difference between a business operating as a ‘cash cow’ or a ‘money pit’. It is important to note that franchises are set up to make the franchisor money at the expense of the franchisee. It is recommended that a potential franchisee engage a solicitor to review the franchise agreement and advise of all risks and obligations.

2. Branding: strong branding will develop customer loyalty, customer retention and a competitive advantage. Branding under a franchise model is managed by the franchisor who will often put clauses in the franchise agreement to protect the brand such as the requirement to engage certain suppliers, fit out requirements and ongoing training.

3. Franchisor Support: franchisors are not bound by legislation to provide a certain level of franchisee support. A potential franchisee should consider whether the franchise agreement caters for franchisor support including ongoing training and marketing. I recommend that a potential franchisee speak to current franchisees regarding their experience with the franchisor.

4. Control: if the potential franchisee is looking for autonomy then a franchise may not be the right business model. Franchisees are held accountable to the franchisor with many aspects of the business controlled by the franchisor.

5. Business life cycle: understanding where the franchise sits in its business life cycle (i.e. start up, growth, established, decline) is key to understanding the franchise risk. The risk and reward should always correlate to the investor’s risk appetite.

SV Partners were previously appointed to a national pizza franchise, whereby at the time, the Company owed over $9 million to secured creditors, unsecured creditors and outstanding employee entitlements. For the solution and outcome of this matters, visit the article on our website.

Before entering into a franchise agreement, it is important to have a comprehensive understanding of the pitfalls and benefits to ensure the business operates in a sustainable environment. It is recommended that professional legal advice is sought prior to entering any business arrangement. If you have a client that is facing financial challenges whether it be in a franchise or non-franchise business arrangement, it is vital that professional advice is sought sooner rather than later to mitigate further loss or exposure to risk.

 

Article written by Rajiv Ghedia, Western Sydney Practice Manager, SV Partners Parramatta

 

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