You should treat purchasing a franchise like buying any other business. As such, you must undertake your due diligence. This article will take you through what due diligence is and explore its key aspects when buying a franchise.
What is Due Diligence?
In a franchising context, due diligence refers to a comprehensive review of the franchise business to understand its prospects of success. Typically, this involves weighing up the financial and legal risks associated with the company and determining if it is worth purchasing.
In some countries, the law requires you to conduct due diligence when buying a franchise. While this is not a requirement in New Zealand, if the franchisor is a member of the Franchise Association of New Zealand (FANZ), they are obliged to provide a prospective franchisee with a disclosure document and allow 14 days before the prospective franchisee can enter into the franchise agreement. FANZ requires all prospective franchisees to receive a disclosure document to help them understand a business’ legal and financial status before purchasing.
Aspects of Due Diligence
1. Documents
The first aspect of due diligence to consider is conducting a thorough review of the relevant documents, including engaging a lawyer. For example, this includes the:
- franchise agreement;
- disclosure document (where applicable); and
- lease documents (where applicable).
Reviewing these documents should be considered the minimum due diligence. This is because prospective franchisees must understand their rights and obligations under a franchise system. This includes knowing the following:
- costs involved;
- how a franchisee can leave the franchise;
- how any restraint of trade clauses will restrict a franchisee at the end of the franchise term; and
- what intellectual property the franchisee can use.
2. Financial Assessment
The following key aspect of due diligence is a financial assessment of the business. Again, a lawyer and an accountant with specialised experience in franchises will be able to assist with this process and provide professional advice. This includes understanding the following:
- initial purchase price;
- ongoing royalty payments; and
- any other payments, such as marketing fund contributions.
When making financial projections and understanding working capital needs, you must assess the above costs individually and collectively. Working capital refers to the money you need for daily business operations, such as buying supplies or paying utility bills.
If a franchise system has a particular relationship with a bank, it is worth speaking with those banking teams during the due diligence period. Again, this will provide unique insight into the company’s financial status and relationships with lenders.
3. Contact Other Franchisees
Another component of due diligence that is useful for a prospective franchisee is to contact existing franchisees of the business. These franchisees will be able to provide invaluable insights into how the franchise system works and how profitable it is. Although the franchisor will give some of these details, existing franchisees can provide their unique insight into how the franchisor runs the business and supports its franchisees.
4. Your Suitability
An often overlooked aspect of the due diligence process is assessing your suitability to become a franchisee. Being a franchisee requires a unique set of skills and balance. For example, although a franchisee needs to be capable of running a business, they equally cannot be too independent or entrepreneurial as they must abide by the rules of the franchise system.
5. Existing Franchises
Financially, where you are purchasing an existing franchise rather than establishing a new one, it is imperative to thoroughly review matters that will impact this business. Your assessment should consider the following:
- lease for the premises;
- existing employment contracts;
- ongoing supply contracts; and
- financial accounts to evaluate the level of profitability.
You must also consider any other authority or consent required to operate the business. For example, in most cases, the franchisor must approve the transfer of the franchise business. Additionally, some businesses require licenses to operate legally. Understanding each of these requirements and assessing whether you meet them is essential as part of your due diligence.
This publication provides you with the fundamentals for franchising your New Zealand business, including set up, branding and management.
Key Takeaways
In a franchising context, due diligence refers to the franchise’s comprehensive review to understand its success prospects. Some critical aspects of due diligence include:
- reviewing relevant documents, including the franchise and lease agreements;
- assessing the financial position of the business;
- contacting other franchisees;
- understanding your suitability to be a franchisee; and
- considering the unique matters associated with buying an existing franchise (where necessary).
If you need assistance conducting due diligence when buying a franchise, our experienced franchise lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0800 005 570 or visit our membership page.
Frequently Asked Questions
In a franchising context, due diligence refers to the franchise’s comprehensive review to understand the franchised business and the franchise network. This typically involves weighing up the financial and legal risks associated with the company and determining if it is worth purchasing.
An often overlooked aspect of the due diligence process is assessing your suitability to become a franchisee. Being a franchisee requires a unique set of skills and balance. For example, although a franchisee needs to be capable of running a business, they equally cannot be too independent or entrepreneurial as they must abide by the rules of the franchise system.
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