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BUYING A FRANCHISE

Thinking of buying into a franchise? It can be a great business opportunity, but you need to be aware of your legal responsibilities, and your franchisor's duties towards you. Here we present the advantages and disadvantages of buying a franchise to aid your decision.

The benefits of buying a franchise

Buying a franchise can be a great way to buy into a business that already has an established brand power, business model and support system. In doing so, it can reduce the amount of time for your business to get off the ground and become profitable. Other potential advantages of franchising include:

 

Relatively low start-up costs. Franchises can generally bring in revenue fairly quickly due to low startup costs and the franchise brand power. 

Franchising can be less risky than starting out alone. The franchise should have already worked out all the kinks in the business model, providing you with a ready-made business with reduced risk. The franchisor should train you in both the practical aspects of the business as well as management. This kind of support is rare for entrepreneurs starting their own business.

 

Brand Awareness. The franchise should already have an established brand reputation and recognition. Customers are already familiar with your service or product, and you need only develop the existing brand with local customers in your area. 

What do I need to buy into a franchise?

Assuming you have already identified a potential opportunity, you will need to ensure that (1) you comply with the franchisor's requirements, and (2) you conduct due diligence to determine whether the franchise is suitable for you.

The franchise will require you to have enough capital to buy into the franchise, or alternatively secure funding to do so. You may have to provide proof of registration of a company, proof of address, a tax clearance certificate, and proof of experience.

Equally, you must conduct proper due diligence into the franchise. Do not be intimidated or made to feel that you are lucky to be a part of the franchise - you should conduct cautious, objective investigation into all aspects of the franchise, including its financial position, marketing model, estimated time to profit, and risks - including the existence of any civil cases against it. Remember that you are considering entering into a close business relationship with the franchise, and the success of the franchise will affect your success - and vice versa. We can assist with due diligence investigations into franchise opportunities.

What must the franchisor disclose to me?

The Consumer Protection Act and its Regulations provide that a franchisor must provide you with a full picture of the franchise, in the form of Disclosure Documents. The Act requires that Disclosure Documents be provided to you before you sign the Franchise Agreement - if not, the Franchise Agreement may be invalid.

The Disclosure Documents must include:

  • information about the identity of the franchisor, its parent companies, its predecessors, and its affiliates;

  • the fees involved in starting and operating the business (franchise fee, royalty fees, marketing fees);

  • information detailing what you will receive as a franchisee, for example assistance in identifying premises and arranging the lease, installation, training, support, equipment and products; and

  • information about the franchise's financial health and any legal issues including litigation;

  • number of franchises and the territory which will be allocated to you.

What documents will I need to sign?

Common documents which the franchisor may require you to sign include:

  • A Non-Disclosure Agreement upon commencement of discussions with the franchise;

  • a Memorandum of Understanding;

  • The Franchise Agreement and Disclosure Documents (in fact, without these, the Franchise Agreement may be invalid)

What are my rights as a franchisee?

Certain provisions of the Consumer Protection Act 68 of 2008 specifically cover the rights of franchisees, for example:

  • You have the right to be given full Disclosure Documents at least 14 days before signing a Franchise Agreement.

  • You are entitled to a cooling off period within which you may cancel the Franchise Agreement without cost or penalty.

As a franchisee, you are also afforded rights under other legislation, like the Competition Act 89 of 1998, covering aspects like:

  • whether you can be forced to use the supplier nominated by the Franchisor

  • whether the Franchisor can allocate territories within which you are allowed to operate, and whether the Franchisor can allow another franchisee to operate within the territory

  • whether the franchise can impose rules like minimum resale price.

What due diligence should I conduct?

It is critical that you conduct full due diligence into the franchise you are buying into - it is a large investment that you are committing to, usually for at least five years. We can assist you with extensive due diligence investigations into a franchisor, including:

  • Business background of Directors and key Executives

  • Financial statement from the franchisor
  • Current number of franchisees

  • Additional training costs to the franchisees

  • Permission to talk to existing franchisees

  • Value, appeal and long-term viability of product/service

  • Restrictions on franchisee’s operations

  • Terms for termination/renewal of agreement

  • Details of other payments due to the franchisor

  • Overview of guaranteed training and support

  • Number & success rates of existing franchisees

  • Franchisor’s site selection/approval rights

  • Realistic estimate of working capital needed

Who handles site selection and who is responsible for the lease?

The franchisor traditionally selects the site where a new franchise will operate, or must at least approve the franchisee's requested site. Take note though that you, the franchisee, are responsible for entering into a commercial lease agreement with the landlord, and for payment of rent.

What if I have a dispute with the landlord?

The most common dispute franchisees find themselves in with landlords, if not concerning rent, is usually around the landlord's provision of a suitable space and facilities for the franchise to do business. Commercial lease agreements are often exceptionally tightly drafted contracts, heavily biased in favour of the landlord. Contact us for an assessment and advice on resolving disputes with landlords with a view to continuing successful trading.

What if I have a dispute with the franchisor?

Disputes with franchisors can take many forms, including:

  • encroachment on your allocated territory by other franchisees

  • the franchisor's failure to provide adequate training or support

  • availability of stock

  • unfair requirements by the franchisor

  • intellectual property infringement

  • the franchisor's mismanagement of advertising funds

and more. Remember that the franchisor is often just another company, made up of people, and they also make mistakes. We have assisted many South African franchisees with disputes not only against local franchisors, but also against international brands. Contact us for advice on a dispute with a franchisor here.

What if I have a dispute with another franchisee?

The most common dispute with another franchisee would take place if you feel that franchisee is encroaching on your territory, or somehow damaging the brand's reputation. In such instances, the question arises whether the franchisor is required to step in, or whether you should act. Franchise Agreements are often carefully drafted to lift liability from franchisors and place them on franchisees, so you may be required to take matters into your own hands, or get a group of franchisees to bring a class action. Contact us for assistance with any type of franchise dispute.

Do I own the business name?

Most often, becoming a franchisee does not make you an owner of the business name. The Franchise Agreement will usually provide for a limited intellectual property licence to be granted to you, allowing you to use the brand name in your trading. You may choose to incorporate your own company to run that franchise, e.g. XYZ (Pty) Ltd trading as Chicken Shop Midrand - but you do not become a part-owner of the brand, nor do you become a partner or owner in the company that owns the Chicken Shop brand.

How can I exit my lease?

That's the million rand question. If you're in such a position that you're asking this question, you have a difficult decision to make, and you may be dismayed to find that you cannot exit your lease without incurring severe penalties. However - depending on the landlord's conduct - you may just have a chance. One of our greatest franchise successes was in assisting a car wash franchisee to exit his lease from a mall and fend off the landlord's claim for hundreds of thousands of rands in future rental. Contact us and let's see if we can help.

Can I sell the franchise?

Sometimes. It depends on the circumstances and what the franchisor will allow you to do. If you're in a position that you need to / want to sell the franchise - or at least exit it - contact us for assistance in discussing a mutual settlement with the franchisor.

What if my franchisor doesn't provide support?

This is a common complaint of franchisees. The franchisor is required to provide support to you - the whole reason you bought into a franchise was to benefit from an established business model, brand reputation and support structure. If your franchisor is not providing support to you, we need to consider either firmly encouraging them to do so, and monitoring them in future - or consider whether the franchisor's failure amounts to a breach of contract entitling you to exit it from us. Remember, exiting a contract is a tricky task and must be done carefully to avoid liability for damages.

What if my franchise contract isn't renewed?

Franchise Agreements usually provide for a minimum period, and MAY thereafter provide for the franchisee's option (used in the legal sense) to renew. It is advisable to motivate for this when negotiating the franchise agreement, but if you do not have this option you may find that you are no longer allowed to continue the franchise. In such an instance you need to give thought to the list of tasks you need to accomplish to exit the franchise - for instance, can you find a new franchisee to take over the premises, lease, contracts, staff etc. - or do you have to exit each agreement?

Remember, when you buy into a franchise, you're putting a lot of trust into the franchisor.

Before you sign, consider getting us to help you conduct due diligence into the franchisor's financials, liquidity, business model and legal risks. Contact us for expert advice on the do's and don'ts of franchising.

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