Franchising under scrutiny: What practitioners need to consider
Perhaps more than ever before, franchising is becoming an increasingly risky business. Due diligence is essential and before a client buys into any franchise model, advisers have a key role to play in protecting their investment.
Nina Hendy | August 2019
Australia’s franchising industry is firmly in the spotlight following a March 2019 parliamentary inquiry report which called for a total overhaul of the sector and the code of conduct under which it operates.
According to the Franchising Australia 2016 survey undertaken by Griffith University’s Asia-Pacific Centre for Franchising Excellence and supported by the Franchise Council of Australia, there are 1120 business format franchises and an estimated 79,000 franchise units in Australia. Sales turnover for the entire sector is estimated at A$146 billion and it directly employs more than 470,000 people.
The Parliamentary Joint Committee on Corporations and Financial Services report proposes substantial changes to the Franchising Code of Conduct and to the responsibilities and powers of the Australian Competition and Consumer Commission (ACCC).
Recommended regulatory changes address: disclosure, franchise registration, supplier rebates, whistleblower protections, unfair contract terms, cooling-off periods, exit rights, collective action, dispute resolution, binding commercial arbitration, alignment of industry codes, churning, education, and leasing arrangements.
Indeed, it draws parallels between the franchising sector and the rogue behaviour uncovered by the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.
“We’re seeing more franchise disputes. There’s a link between the indicators of financial stress on franchisees and the level of disputes. As the economy tightens and financial performance is impacted, I think there will be more.” Peter Knight FCPA
While franchising is one of the fastest-growing industry sectors in Australia, director of Robert Bryden Lawyers, Robert Bryden, maintains that the number of issues between franchisors and franchisees seems to be growing at a faster rate than the number of franchises.
“People new to business, investing their life savings or a redundancy [payout] to buy a franchise are often driven by their heart, not their head,” Bryden says.
“As a business adviser, learn to recognise the signs. Accountants are the first port of call, not only as numbers people but as trusted business advisers.”
What can accountants with franchising clients do?
Knight Partners founder Peter Knight FCPA, a franchise accounting and tax specialist, is currently dealing with a high-profile dispute involving some of his clients who have lost hundreds of thousands of dollars to an unscrupulous franchisor.
“We’re seeing more franchise disputes,” Knight says. “There’s a link between the indicators of financial stress on franchisees and the level of disputes. As the economy tightens and financial performance is impacted, I think there will be more.”
He believes practitioners should be more involved with franchisee clients to help them spot early red flags.
“We can give advice regarding the structure of their financing. We’re also seeing an increase in short-term lending, at extremely high interest rates. This is only a short-term fix and will have a disastrous effect over the longer term if the finance is not reset to a more appropriate level.”
Kerry Miles is director of FranchiseED, which partners with selected organisations and universities to conduct independent research on different aspects of franchising.
The research is often focused on improving franchise performance and identifying underlying issues, trends and solutions for franchise challenges.
She hopes the parliamentary inquiry will make it easier for potential franchisees to determine the viability of different franchise models.
“Research has shown that a great source of conflict in franchise relationships comes from mismatched expectations,” Miles says.
“The new franchisee is expecting something that the franchise doesn’t deliver. These mismatched expectations can lead to resentment and the breakdown of relationships and end up [becoming] disputes.”
She wants an independent and transparent rating system introduced based on measurable outcomes backed or supported by the government.
“It’s quite difficult to determine the truth versus fiction when assessing a franchise and it takes time and expertise to do this, which is not easy for the mum and dad investor,” Miles says.
8 tips for accountants to help clients avoid franchise disputes
- Look out for “churn and burn” operators – particularly where an existing franchisee wants out and the broker and franchisor represent it as a purchase from the franchisor.
- Alert clients to the dangers of being influenced by suggestions that “other purchasers” are also interested in the same outlet. It may be a simple set up or sales technique.
- Recommend seeking advice from a lawyer expert in franchising. It’s a highly technical area with disclosure statements and franchise agreements to be negotiated and explained in detail.
- Closely assess existing staff as they will likely stay on for a period and sometimes have allegiances to the prior franchisee or (in the case of a site being owned and operated by the franchisor), the actual franchisor.
- Be suspicious about any financial projections provided by franchisors for new sites.
- Recommend that the client request to see financial statements from several other franchisees operating in a similar geographic/demographic to the site on offer. Compare them to any financial projections provided by the franchisor.
- Consider site alternatives. Advise clients to follow their instincts and not rely on what a broker or franchisor suggests is a great location.
- A significant number of claims against practitioners can be defended successfully if proof of advice is available. Keep notes of all conversations with clients on file so that if things don’t work out, you’re covered.
Source: Robert Bryden, Robert Bryden Lawyers, Sydney.