Franchisee Due Diligence Checklist

If you feel like slogging through every single news story about wage underpayments that’s emerged over the last couple of years, you’ll undoubtedly notice a common thread – that an overwhelming number of businesses guilty of underpaying staff are part of wider franchise networks.

Within those franchise networks – 7-Eleven and Caltex among them – are a number of franchisees who claim that they had no choice but to underpay employees, due to being sold fundamentally unprofitable business models.

If you look online – on Facebook pages like Australian Franchising Scams or forums like Blue MauMau – you’ll find scores of franchisees who feel they’ve been burned by franchisors. These franchisees claim they were misled, that they didn’t fully understand the magnitude of work involved, that the amount of money they thought they’d make was way off base.

And it’s a pretty safe bet that most, if not all of those franchisees, didn’t perform thorough and comprehensive due diligence before purchasing a franchise.

What is due diligence?

Due diligence, broadly, refers to the investigation of a business or person prior to signing a contract.

In franchising, this basically means looking at all of the legal, financial and business implications of buying a particular franchise.

There’s no specific process or checklist for this process (though are some great resources online), and it can be comprised of a number of steps – from speaking to other franchisees in the network, to running credit checks, to simply Googling the company.

At its heart, due diligence allows a potential franchisee to make sure the franchise is an investment worthy of both their time and money, and to know exactly what they’re getting themselves into.

Why is it important?

You wouldn’t (at least, I hope) buy a used car without getting a vehicle inspection to make sure you’re not buying two smashed up cars welded together. Nor would you buy a house (again – I hope) without getting a pre-purchase inspection to make sure it’s not mainly made of termites.

Hell, most of us won’t even buy cologne or a kettle or a cat feeder without checking online reviews first.

Buying a franchise is a significant investment (you’re looking at an average of $250,000 to set up your own franchise) and you need to take as many steps as possible to ensure you’re spending your money wisely.

Does everyone do it?

As wise as performing thorough due diligence is, not everyone does it before purchasing a franchise. In fact, a joint study by the Asia-Pacific Centre for Franchising Excellence at Griffith University, and University of New South Wales, and funded by CPA Australia, found that due diligence rates among franchisees were pretty dismal.

The study found the following:

• Only 21% of franchisees surveyed visited franchisees to find out more information
• 57% spoke to other franchisees
• Only 64% sought the advice of a lawyer
• 54% obtained advice from their accountant
• 54% conducted desktop research

Seeing an accountant is generally the most common form of ‘due diligence’ undertaken by prospective franchisees. However, generally these people aren’t seeking the advice of accountants specifically in the small business or franchise space – instead, they’re relying on their normal accountant to advise them on these fairly complex matters.

Alarmingly, more than a third of those surveyed didn’t employ the services of a lawyer, trusting that the franchise agreement provided by the franchisor would be 100% above board and fair.

What are the limitations of due diligence?

While taking your time to investigate the franchise you’re thinking of buying into is smart, there’s always going to be things your research won’t be able to tell you.

That doesn’t mean due diligence is a waste of time (far from it!), but it does mean you should always take everything you learn with a grain of salt. Let’s take a look at three pretty significant limitations:

Legal stoushes

Looking up publicly-available court rulings is a great way to get a snapshot of what the franchisor is like – if the franchisor is constantly battling with vendors, suppliers or other franchisees in court, you may want to consider whether if that’s the kind of business you want to be a part of.

However, the majority of franchise disputes are settled in mediation – and there’s no public record when that happens.

NDAs

Talking to other franchisees is a key fact-finding activity, since they’re more likely to tell you how it is and avoid sugar-coating things.

However, if a franchisee has had a dispute with the franchisor that’s been settled in mediation, that franchisee may have had to sign a Non-Disclosure Agreement – which means, legally, they can’t tell you about the dispute.

Other entities

The franchisor is required to supply something called a Disclosure Document to a prospective franchisee, which provides, among other things, financial reports on the franchisor for the last two years. (If in operation for less than two years, then a stat dec confirming solvency and an independent audit report must be provided.)

The Disclosure Document must contain this information about the franchisor. However even though most franchises operate within a group of companies, the Disclosure Document does not need to include financial information about any other companies in the group.

So if you’re looking at say, a pizza franchise that’s within a group that also contains a chicken franchise and a donut franchise, you’ll not get details on how the chicken franchise or donut franchise are performing. And if one is performing poorly, that could put financial pressure on the brand you’re looking to buy into.

No base for comparison

While you can look at the Disclosure Document thoroughly, you generally don’t have anything with which to compare it. In Australia, there’s no public database of Disclosure Documents – so while you can look at all the financial and operational details of a specific pizza franchise, you have no way to compare them to the 30 other options in the market.

So what should you do?

Let’s keep this simple. You need to do due diligence. You need to do thorough due diligence. Yes, it can be expensive and time-consuming. But the same can be said for running a failing business.

Here’s what you need to do:

• Have a lawyer well-versed in franchising look over your franchise agreement, and make changes if necessary. Don’t assume that the agreement provided by the franchisor will be airtight.
• Seek the advice of an accountant well-versed in franchising to look at all financials and give advice as needed.
• Make contact with other franchisees in the area, and establish how they feel about the franchisor, and the level of support and training they provide.
• Spend some time observing other franchises from a distance to get a gauge of traffic, staff behaviour, promotional material and so on.
• Look for Facebook groups or online forums where franchisees get together to talk about the franchisor.
• Check Google, Facebook, or other sites like Zomato and Yelp for customer reviews of other franchise outlets under the same brand.
• Check BlueMauMau for any reviews or complaints by franchisees.
• Perform a credit check on the franchisor.
• Speak to peers, family, friends, to gauge how the brand is perceived in your circle.
• Search court records to find any disputes between the franchisor and franchisees. These should also be in the Disclosure Document.
• If you don’t understand something, seek clarification or assistance – don’t just brush it off.
• Take your time. This isn’t something that you can do in a weekend. Some franchisees spend 12 or more months doing thorough due diligence.
• Read everything. Then read it again. Know everything that you’re agreeing to inside out.
• Know your rights. Read the Franchising Code of Conduct, and make sure you understand it.

Buying a franchise is a gamble – but then, most things are. You could do everything right, and still end up with an unprofitable business that’s more lame duck than soaring eagle.

But, as they say, knowledge is power. And thorough, comprehensive due diligence is the best way to avoid any nasty surprises down the track.

Do your homework, and make sure you know exactly what you’re getting into. Because if you end up resorting to underpaying your employees just to pay the bills, you could end up facing significant fines from the Fair Work Ombudsman.

And as arduous as due diligence can be, it has to be easier (and cheaper) than that.