Financial and Legal Risks to Consider When Buying a Franchise in NZ

In Short:

• Consider the financial risks, such as working capital, consumer demand, suppliers, and fees.

• Carefully review franchise agreements, disclosure documents, and potential personal guarantees.

• Understand the implications of purchasing an existing franchise, including obtaining franchisor consent and conducting thorough due diligence.

Tips for Businesses:

Before purchasing a franchise, ensure you understand all financial obligations, including working capital, fees, and supplier relationships. Legally, be clear about the franchise agreement terms and any personal guarantees. For existing franchises, confirm franchisor approval and assess assets for debts. Always seek legal advice to minimise risks.

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Table of Contents

• Financial 
• Legal
• Key Takeaways 
• Frequently Asked Questions

New Zealand has the most franchises per capita, making this a popular business model. However, you must assess the associated financial and legal risks when considering purchasing a franchise. This article will take you through seven financial and legal risks to consider when buying a franchise. 

Financial 

1. Working Capital

Prospective franchisees must consider working capital and what this means for their ability to establish and build a sustainable business. Working capital refers to the money needed for daily business operations, such as buying stock or paying utility bills. It will likely take some time for a franchise to generate revenue. This is the case even if the business is already running successfully. As such, you must build working capital costs into your budget from the start. Failure to do so can cause issues in the long run.

2. Consumer Demand

It is essential to consider that consumer demand will differ in every geographical location. Therefore, although one type of franchise or location may perform well, this does not mean every other franchise will find the same success.

Ultimately, this insight and awareness can help reduce financial risk. 

3. Suppliers 

The nature of franchise agreements means that as a franchisee, you will not necessarily have the choice of where to buy your supplies and stock. For example, suppose your franchise agreement stipulates specific vendors. These terms bind you to use these vendors. Although you might find cheaper products through another supplier, your franchisor may have long-term contracts in place with existing suppliers. Considering these existing relationships will allow you to understand some of the commercial aspects that will impact your financial projections when buying a franchise. 

4. Fees

In most franchise arrangements, the franchisee pays a regular royalty fee to the franchisor. Therefore, you need to know the quantum and frequency of the royalty fee payments. For example, consider whether royalty fees are a flat fee or a percentage of your sales. Similarly, determine whether advertising and marketing fees will be separate. Having detailed answers to these questions will ensure you are more prepared for the financial obligations of the franchise agreement. 

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Legal

1. Franchise Agreement and Disclosure Document

You should carefully read the franchise agreement and, if provided by the franchisor, the disclosure document and any other ancillary documentation. If you need clarification, you should speak to the franchisor or your lawyer before signing the franchise agreement. It is common to make amendments to the franchise agreement before signing.

A franchise lawyer will be well-equipped to assist you with this. They have experience reading these documents and will know what types of questions to ask. For example, you should satisfy yourself with the following:

• whether an exclusive territory will be granted;
• what the operations manuals look like;
• the length of the agreement term;
• any exit clauses in the agreement; and
• the circumstances the franchisor can terminate the contract.

Understanding your legal obligations will help minimise risks once the franchised business operates. 

2. Personal Guarantees

Most franchise agreements include guarantee provisions. These provisions make the guarantor personally liable for the franchisee’s obligations under the contract. Therefore, you should speak to your accountant and lawyer to limit your exposure due to these guarantees. Although most franchisors will not remove guarantee requirements, there are steps you can take to protect your assets. 

3. Existing Franchises

The franchisor’s consent likely must be obtained if you are looking to buy an existing franchised business. Occasionally, a franchisor may not agree to the proposed sale. In that case, they may have refusal rights or impose conditions on you as the new franchisee. This makes it critical that the sale of the business agreement is conditional upon obtaining the franchisor’s written consent.

Key Takeaways 

If you are considering purchasing a franchise, assess the financial and legal risks adequately. This includes risks associated with the following:

• working capital;
• consumer demand; 
• suppliers;
• fees;
• franchise agreements and disclosure documents; 
• personal guarantees; and
• issues associated with buying an existing franchise.  

If you need assistance understanding the financial and legal risks associated with 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