By Joseph Y. Adler
When prospective franchisees start seeking advice about purchasing a franchise, they are often in a state of euphoria about what they perceive to be the most exciting business opportunity available. Not much could dissuade them from pursuing such an opportunity.
It is important, however, for prospective franchisees to avoid getting caught up in this excitement over owning their own business and to conduct extensive due diligence before making a commitment. This is particularly important because purchasing a franchise usually involves a substantial investment—and, if things turn sour, significant liabilities.
Understanding the business model
A prospective franchisee should first appreciate how the franchising business model differs from the business model for an independently owned company. Despite common wisdom to the contrary, a franchisee does not truly ‘own’ a franchise at all, but rather is licensed to operate one.
Further, franchise relationships are generally long-term, one-sided contractual relationships, largely in favour of franchisors. Many franchisors go to great lengths to monitor and control the way their franchisees operate their businesses, due to the franchisors’ desire to protect and enhance the value of their brands. In this sense, franchisees do not truly have much discretion over how they operate their businesses, as they are bound to comply with very stringent rules imposed upon them by their franchisors.
Seeking professional advice
One should not underestimate the importance of retaining professionals with relevant experience as early in the franchising process as possible. A prospective franchisee should consult with a franchise lawyer, for example, who can help him/her understand his/her rights and obligations under applicable franchise legislation and interpret the disclosure document and franchise agreement. Currently, franchise legislation exists in the provinces of British Columbia, Alberta, Manitoba, Ontario, New Brunswick and Prince Edward Island.
A franchise lawyer should also offer full legal advice surrounding the purchase of a franchise. If a prospective franchisee intends to purchase an existing franchise unit, rather than a newly established one, then he/she should hire a franchise lawyer to assist him/her in conducting the necessary due diligence before entering a binding, unconditional deal with the existing franchisee. This process will include the same types of searches that are customarily undertaken when planning to buy a non-franchised business.
In addition, a prospective franchisee should retain a professional accountant with expertise in franchising to help review the financial statements shared by the franchisor within the disclosure document. This review may reveal certain strengths and weaknesses of the franchisor and its system.
While consulting with these accountants, the prospective franchisee should also prepare a business plan, to arrive at a more accurate assessment of (a) the value of the franchise to be purchased and (b) the feasibility of deriving a return on investment (ROI) within a reasonable period.
On occasion, a franchisor may make a financial performance representation, such as a historical claim, in which case a prospective franchisee should carefully assess the representation with his/her professional advisors. He/she should also attempt to confirm the accuracy of the representations with as many existing franchisees as possible.
Finally, a prospective franchisee is encouraged to consult with his/her bankers to obtain any necessary financing and to solicit their opinions, from a financial perspective, about the franchise system under consideration.