Mondovo

What are the Risks of Becoming a Franchisee?

risk of franchising

Many people have a desire to start their own business, chasing the dream of independence, control of their own destiny and, hopefully, riches.

But for many the risks associated with launching a new business are too great. This is where running a business as a franchisee is often seen as a viable alternative. By operating within a franchise you can avoid many of the issues which cause start-up businesses to fail, such as establishing a brand name and identity, forming new work practices, training and staffing.

There are also, however, risks and pitfalls involved in becoming a franchisee. Some of these are outlined below but in any event, before embarking on any franchise agreement, you should consult a legal professional with experience in this area to help clarify the best way forward.

What are the advantages of running a franchise?

A franchise arrangement involves a contractual agreement between a franchisor (the owner of the franchising business) and the franchisee – the person given permission to use the business’ name, procedures, business model, branding and marketing for an agreed period of time. Under the agreement the franchisee is given the right to offer, supply and distribute goods and services under conditions set out by the franchisor.

There are a number of advantages to running a business as a franchisee compared with starting a business yourself, including:

  • The franchise business will generally have an established reputation and image, proven management and work practices, access to national advertising and ongoing support. It’s often portrayed as running a small business inside a big business network. Poolwerx, Boost Juice and Coffee Club are some examples of successful Australian franchises.
  • Training in set-up and operation of the business will often be part of the agreement with the franchisor.
  • Securing finance from a lender may be easier if you’re setting up a franchise as the amount sought will often be less than if you start a business yourself.

What are the risks of taking on a franchise?

While there are some clear upsides to taking on a franchise agreement, there are some equally clear downsides which any prospective franchisee should very carefully consider. Consulting a lawyer with franchise experience is highly advisable in light of some of the concerns touched upon below.

Some of the disadvantages include:

  • The franchise agreement brings with it restrictions on where you operate, the products you sell and the suppliers you use.
  • The agreement will set out some fairly prescriptive terms on how you run the business, from staff uniforms to use of logos and design of a store, so be aware this leaves little room for the ideas and creativity you might bring to a business you personally own.
  • Bad performances by other franchisees in the network may affect your franchise’s reputation. This is a genuine and well documented problem that has occurred in some well known ‘chains’.
  • The franchise agreement will mean you share profits with the franchisor in an ongoing manner. There are also a number of other ongoing costs to be aware of, which might include franchise renewal fees, advertising and transfer fees, employee and management training fees, and other royalties.
  • At the end of the franchise agreement, the franchisor is generally under no obligation to renew the agreement… which can leave your business high and dry.

Set-up fees can also be a significant downside for a franchisee. Depending on factors such as the prominence of the franchisor’s brand and the location of the business, initial fees to set up can start as low as $5000 and go as high as $1 million in Australia. There is the risk, obviously, that this money will never be recouped if the franchise then underperforms.

The points above demonstrate that a process of due diligence before taking on a franchise agreement is strongly advised.

Beyond those risks, franchising arrangements are governed by an industry code of conduct within the Competition and Consumer Act and regulated by the Australian Competition and Consumer Commission, which can be found here. It sets out standards for disclosure, procedures for dispute resolution, good faith obligations, cooling off periods and procedures for ending franchise arrangements. Failing to comply with franchising industry codes could incur up to 300 civil penalty units (approximately $63,000).

In conclusion

It’s common for people who decide to take on a franchise arrangement to be changing careers, or running a business for the first time. This lack of experience makes it even more important to seek the advice and guidance of someone qualified in identifying both the risks and rewards of franchise agreements. Many firms retain experienced franchise lawyers who can help guide you through the process so get in touch today if you’re considering taking on a franchise business.

Book now