last updated 19/01/2011
Advice Makes All The Difference
last updated 19/01/2011
Choosing a new life for yourself can be fun. Browse through the Opportunities section of our Directory and you'll find all sorts of opportunities in industries you might never even have thought of. There's certain to be something that appeals so go ahead, contact the franchise and find out more.
Once you start getting serious, though, you'll need to do a bit more homework. Some of this will mean your asking lots of questions, reading documents and talking to people, but there will be other areas where you need to get others with specialist knowledge to do the work for you. These people are your advisors, and they will be critical to your future success.
Why Do I Need Advisors?
As New Zealanders, we like to think we're pretty self-sufficient. If we can't do something ourselves, we have a mate who can. That's great for many things, but not so good when it comes to buying a business. That's an important decision, much more so than buying a car or even a house. It affects your finances, your family, your career and your future, so it's best to get good professional advice from a specialist lawyer, accountant and banker.
Here are some more good reasons why it's worth spending a little time and money on advisors, no matter whether you're buying a lawnmowing franchise or a million dollar restaurant:
1. You'll save time and money. Choose experienced advisors and they'll probably have come across the franchise system you're investigating before. Even if it's new to New Zealand, chances are they will be able to find out more about it from contacts overseas than you will. And if it's a brand new system, they will at least know the characteristics to look for in a successful franchise. They might cost more per hour than non-specialist advisors, but they will give you better advice and take less time about it.
2. You're less likely to make mistakes. You might not know what rents or margins are normal in a certain industry, but your advisors should. You might not know whether a sub-lease arrangement leaves you exposed, but your lawyer will. You may be new to business borrowing, but your banker will know what is and isn't possible - and the fact that you are buying a franchise may mean special terms are available if you talk to the right people.
3. You'll know what to expect. One of the most important tasks of your advisors is to ensure that you know exactly what the franchise entails and that you know what will be expected of you as a franchisee. That will help you to make the right choice of business but also enable you to settle into your new role faster.
4. You'll be confident your chosen franchise will meet your needs. Whether your reasons for buying a franchise are short-term growth, long-term security or lifestyle, involving advisors and briefing them honestly about your goals will help ascertain whether the business will really meet your needs.
5. You'll get impartial advice. If you find a business you love, it's easy to focus on the positives and miss some of the warning signs. For all sorts of reasons, a good franchise may not actually be the right one for you. Advisors can help you see beyond the dream to the reality and help you make the right decision.
Will It Make A Difference?
According to research conducted in Australia a few years ago by Dr Lorelle Frazer, the second most common cause of franchisee failure is ‘Poor choice or inadequate research by franchisee'. Number five on her list was ‘Expectations of an easy life' and number eight was ‘Finding the franchise fee a burden'.
While the failure rate of franchisees in New Zealand is very low (surveys suggest some 94% of franchisees survive at least the first three years), Dr Frazer's list would also apply to causes of other problems such as under-performance, unhappiness or the early sale of the business. However, all three of these causes would have been reduced considerably had the franchisees in question taken good professional advice before buying their business.
So why didn't they? Having talked to a few troubled franchisees myself, it seems that too many either assumed that everything would be okay because the franchise had a good reputation, or thought they would save money they wanted to invest in the business, or used an inappropriate advisor - the family lawyer, for example, who might be great at conveyancing but had little experience and few contacts in the franchise world. Alas, they learned an important lesson the hard way.
In fact, franchise professionals - including franchisors - believe that getting good legal advice is so important to a prospective franchisee that it is actually written into the Franchise Association of New Zealand's Code of Practice. Rule 11.2 states that ‘Before the execution of any franchise agreement Franchisor Members will require each Franchisee to either:
(a) Produce a certificate from a solicitor certifying that the solicitor is acting independently for the Franchisee and has explained the franchise agreement (and preliminary agreement if there is one) to the Franchisee; or
(b) Sign a statement that the franchise agreement has been explained by a solicitor or that the Franchisee declined to take independent legal advice.'
Similar provisions are actually enshrined in law in some countries with franchise legislation. The message is clear: if you're buying a franchise, consult the professionals.
What Advice Should I Actually Get?
Having made the wise decision to consult professional advisors, you also need to know what to expect from them. The three key people that you need to speak to are a lawyer, accountant and banker.
When you buy a franchise, you are getting into a legal arrangement which involves rights and obligations on both the franchisee and the franchisor. It is therefore extremely important that you should have a clear understanding of what those rights and obligations are, and what they will actually mean to you in practice.
Franchise agreements can be lengthy (40 pages is not uncommon) and tend to be written in legalese. Part of the role of your lawyer, therefore, is to go through it with you and explain how it will affect you in creating, running and ultimately selling your business.
Three of the key elements that should be covered with you by your lawyer include:
The nature of the franchisor/franchisee relationship. In any franchise agreement, you will find that the franchisor has more power than the franchisee. This is because the franchisor is the owner of the trademarks and intellectual property contained in the operating system and needs to be able to protect that property against mis-use by franchisees. In most cases, this power will be applied to protect your own business against the actions of ‘rogue' franchisees in the same system; however, it is also possible and occasionally necessary for franchisors to use their power to force through other changes. Your lawyer should make you aware of specific clauses and their possible impact.
The obligations on both parties. These will vary from franchise to franchise, but for a franchisee may include operating according to the franchisor's system, stocking certain core items and maintaining certain standards relating to items such as signage, opening hours or uniforms. There may be minimum performance requirements and obligations relating to reporting or accounting procedures. Failure to fulfil any of these obligations may be grounds for termination of the franchise, so you need to understand these key requirements. The franchisor's obligations will also be set out in the franchise agreement and will probably include such things as maintaining the manuals, providing certain products, services and support, and training.
The terms. Unlike an independent business, you don't purchase a franchise outright; rather, you are granted the right to operate the business for a set term, often with one or more rights of renewal at the end of that term. A good lawyer will not only check that these terms (and any conditions for renewal) are fair and reasonable but will also ensure how the terms relate to, say, any lease agreements that may also be required to operate the franchise.
‘In addition to the above, there are any number of other areas an experienced franchise lawyer will investigate and go over with you,' says Stewart Germann, one of New Zealand's best known legal specialists. ‘These would include the availability of manuals, confidentiality issues and the ownership of trademarks and systems as well as fees. For running the business, various product supply, training and operational assistance issues all need to be covered, and one that is often missed is the need for appropriate insurances. Then there are various considerations relating to leaving the business: apart from causes for termination, what are the restrictions (if any) on resale, does the franchisor have a first right of refusal and are there any transfer fees payable? Some franchisors impose a two year non-assignment provision which locks in a franchisee for the first two years, so a good lawyer should cover that too. Another consideration is whether there is any restraint of trade covenant and how that might affect you if you already have some skills or experience in the same industry.'
One other area in which it is wise to ask your lawyer's advice is how to structure your new business. Limited company, partnership, sole ownership or a trust? ‘Different structures suit different circumstances, and it is important to ensure that you select the right one for your own needs,' says Stewart. ‘It may also be wise to consider the creation of a trust to protect your family assets from the consequences of any business problems. Much thought needs to be put into the most suitable structure.'
With the need for good legal advice clear, how about using an accountant? Well, one of the primary reasons for buying a business is to make money, so you want to ensure that the franchise you are considering is actually a sound proposition, that it is affordable and that it can actually provide the financial returns that you are looking for. You need to use an experienced accountant who will help you investigate this.
The financial assessment of a franchise should examine the investment from the following perspectives:
- The investment required to purchase the franchise
- The equity/borrowing structure of the franchisee
- Additional working capital requirements (debtors/stock)
- Budgeted sales and profitability
- The costs involved in establishing the business
- The returns on investment taking into account the working wage of the franchisee
- The financial risks of the venture
‘There are two major tools that your accountant will use,' explains Colin Theyers, an experienced franchise accountant and managing director of Staples Rodway. ‘These are a sensitivity analysis and a detailed budget and cash flow.
‘In conducting a sensitivity analysis, we take the likely sales, gross margins, and expenses split between fixed and variable costs (including all franchise-related items such as royalties) to calculate a trading profit. We assess the cash repayment requirements for any loans required, and the wage expectations of the franchisee. Once we have these, we can then develop a high level cash flow forecast, and endeavour to match this against the experiences of other franchisees within the system.
‘Having developed a realistic plan, to cover the uncertainty of sales figures we then test the plan by applying different levels of sales - generally 10-20% above and below the base figure to demonstrate the financial implications of major variances in sales. We look carefully at the impact of fixed costs on the results and determine at what point the franchise will break even. Obviously, if fixed costs are high then lower than expected sales will dramatically reduce profitability and the ability to repay borrowings.'
A detailed budget can then be prepared using the most likely sales and cost mix. It's important to include all items of expenditure, however small, and to include them at the correct time. While an annual expenditure of $5,000 on, say, stationery, might not make a major difference to the annual budget, if it comes as two major items of $3,000 and $2,000 it could make an important difference to your cashflow - and therefore your borrowing or overdraft requirements. Generally, experienced franchisors are pretty good at estimating these elements accurately, but it is still important to have your accountant check them out.
‘We use a number of spread sheet models which translate this data into a comprehensive financial and cash flow budget which incorporates tax, debt repayment, working capital and capital expenditure movements,' says Colin. ‘The budget is then refined until it will realistically represent as far as possible, the trading pattern of the franchise. This final budget serves a range of purposes, including being a detailed financial assessment of the proposed investment, an operational budget should the investment proceed, and a document to support an application for funding.'
And at that point, you need to consult expert advisor number three - the banker.
The good news about franchise bankers is that they have a huge amount of expertise and knowledge about different franchise systems but they aren't actually going to charge you anything for sharing it. It's therefore a simple matter to talk to them fairly early in your researches to find out what they know and start to build a relationship with them. By building a team of advisors - lawyer, accountant and banker - you can be confident that you are giving yourself the best possible chance of creating a flourishing business that will repay the effort you put into it.
Most of the major banks now have franchise departments with specialists all over the country, so rather than talking to your regular bank manager get in contact with them. Your preferred franchise may already have a preferential arrangement with a particular bank so make sure you contact them, but check other options too.
The information the bank requires from you will vary according to the franchise and your own circumstances. All the banks listed in our Directory section have detailed information packs available.
Buying a franchise, whether a new or existing one, may look daunting initially. With the right team of advisors behind you, however, it can be easier - and much more certain - than it first appears. The trick is to choose the right franchise advisors in the first place, be honest with them and listen carefully to what they have to say. At the end of the day, the decision whether to proceed or not will be yours and yours alone, but if you have listened to the voices of experience then you stand the best possible chance of making the right decision for your future success.
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