FRANCHISES VERSUS INDEPENDENT BUSINESSES

Basics of Franchising

Franchising in New Zealand is big business.  There are about 450 franchise systems across the country, employing over thousands of people.   From McDonalds and Subway to the smaller lawn mowing and cleaning businesses, there is a franchise available in almost any goods and service industry you can think of. 

So what is franchising exactly?  Franchising is essentially a method of distributing goods and services.  It provides big business with the ability to expand their distribution and presence while providing small business with the methods and resources of an established system - at relatively low financial risk for both parties.

And while it’s considered that franchising has matured in this country and steadied in the past year, there is no doubting the growth experienced by franchising over the past 30 years in New Zealand.  From the early 70's when some of the first franchise systems - McDonalds and Pizza Hut - reached our shores, franchising has expanded to one of the fast growing sectors of our economy.

And there is a good reason why franchising is proving a popular choice for those that want to be their own boss.  A franchisee has a success rate much greater than stand-alone or small business. 

One of the key success factors of traditional franchises is in the standardisation of all aspects of the business - from the product to the marketing strategies and operational standards.  The franchisee is given the right to sell an established product or service in addition to the use of brand names, trademarks, copyrights, patents, storefronts and interiors.  It’s a powerful method to duplicate and expand the network and distribution of products and services for the franchisor, while providing the franchisee with all the necessary tools and methods to operate the business.

There are considered four types of franchising.

Business Format Franchises

These are the franchises you will be most familiar with and feature throughout BuyaBiz.  In this arrangement, the franchisor provides a franchisee with the process, methods and opportunity to operate a business using the name and trademark of the company.  In addition they may also get access to product, storefronts, staff training and marketing strategies, and in return the franchisee pays a fee or royalty.

Product Format Franchise

As the name implies, this type of franchise involves products, and is primarily used to set up distribution networks through dealer companies.  It is also known as a Manufacturer-Retailer franchise type.

This allows the franchisor to define the marketing of the product and can also limit the sale of competitive products through dealers.  In return the franchisee receives the recognition of a well established product and can receive additional benefits through the association with the franchisor including marketing support.  An example may be Arnott’s Tim Tams in a supermarket.

This is quite a common franchise model for tyre and auto companies. 

Manufacturing Franchises

Another variation of the Product Franchise, the Manufacturing Franchise gives a franchisee the rights to manufacture and sell a product to the public, using the franchisor’s name and trademark.  This method is popular with bottlers of soft drinks and alcoholic drinks.

Business Opportunity Ventures

These are generally smaller scale franchise opportunities that require the business owner to purchase and distribute the products for one specific company.  The company provides customers, accounts or regions to the business owner and, in return, the business owner pays a fee or royalty.  Examples of these include vendor machine distributors.

For the purpose of this site, we will refer to the most common form, ‘business format franchises’, as simply franchises.  And while they share many similarities to an existing business, there are several distinct differences.

Differences between Franchises and Independent Businesses

Franchising is essentially a business system that delivers products and services to a particular market place under the franchisor's brand or trade mark, in return for a fee. The fee may be a combination of an upfront payment and an ongoing royalty.

Franchising allows a person to set up their own business, but their business is supported by a tested business system. This is known as a "business format" franchise. In these types of business the franchisor provides training, equipment, marketing tools and brand recognition.

The key to the success of the franchise model is the support & collaboration of the proven system. Business is always about building a system and franchising offers an efficient way of delivering business systems to anyone who wants to be in business for themselves. In many respects, purchasing a franchised business is very similar to that of purchasing an independent business.  BuyaBiz offer both business types for sale.

The most notable difference in purchasing a franchise is that a franchised business has a level of support provided by the franchisor and its franchise network compared to operating a small business on your own.  Statistically a franchised business has a higher likelihood of success in comparison.  One of the key advantages is the established brand recognition, especially in the first few years.

Another notable difference between purchasing a business and that of a franchised business is that as a franchised business owner, you are bound by the directions of the franchisor.  As an independent business owner you enjoy the freedom to determine the direction of your own business.

The legal process and documentation required for purchasing a franchised business is the same as a non-franchised business with exception of some further documents as outlined in this article.

What Franchise is Right for you?

Firstly assess your own skill level. Are you suited to this type of franchise? Are you too independent? If so you be unsuited to buying a franchise. Equally if you are too dependent on others you may be unsuited to purchasing any business and you may be better working for someone else. If you think franchising is right for you, you should take into consideration:

  • Background in respect of the franchisor.  This includes the experience of the directors of the franchisor and how long they have been offering this particular business system, how the existing franchisees in the system consider their support and do they recommend the system. 
     
  • The franchised business needs to be assessed in terms of the business itself, its overall market potential and its existing or likely competition.
     
  • Financial considerations - is the business an existing or a new or Greenfield site?  What return on investment is being achieved by other franchisees?  How long it will take to achieve profitability necessary to support your required income levels?  What fees are payable and what potential is there for capital gain?
     
  • The Franchise Agreement needs to be reviewed and advice sought from a franchising lawyer.
     
  • The franchise territory needs to be assessed as to whether you gain an exclusive territory or if not the likelihood of further franchises being offered in the territory.

This is some of the due diligence required by you in considering whether the franchise itself is a good investment opportunity.  But there are further factors relevant to whether the franchise is right for you.  If it has passed the above hurdles and is worthy of further consideration, you should consider more personal issues. 

  • Is the location near your home or are you required to relocate to another location to make it work?
  • Are you prepared to follow a system are you too entrepreneurial that you would prefer to adopt your own ideas
  • Is the business sector one that is growing or one that may be stagnating?
  • Do you have sufficient capital to suffer unforeseen difficulties?
  • Have you prepared a detailed business plan and a detailed exit strategy that fits within the parameters of the Franchise Agreement?

Ultimately you may consider having a similar demographic analysis done in respect of the site, particularly if you are acquiring a Greenfield site.

A detailed business plan that you have prepared in advance of searching for a franchise can help you ensure that your plans and aspirations detailed in the business plan are met by the particular franchise you are considering.  Issues such as hours of work may well impact upon which franchise is right for you.

Whether you feel a business or franchise is right for you, be sure to explore all the options available and its good to compare one business against another.  Browse an industry of interest on BuyaBiz and review the current opportunities.  Google is also a handy tool to research a business of interest and trade magazines can be a useful resource for industry news.  Speak to family and friends or seek the assistance of a business advisor.  Try to learn as much as possible about the industry to ensure you know what to expect.

Disclosure Documents

A franchisor should give full disclosure of a number of matters to the franchisee. This is before receiving any non-refundable money from the franchisee or before the franchisee enters into a Franchise Agreement. It is called a “Disclosure Document”. That disclosure document is similar to a company prospectus and describes valuable information about the franchisor, the system and the franchise agreement. Franchisors should update their Disclosure Document at least annually.

If the franchisor is a member of the Franchise Association of New Zealand Inc (FANZ), the Disclosure Document must be given to a potential franchisee at least 14 days prior to the franchisee entering into a franchise agreement. 

Typical details found in a disclosure document include:

  • information about the franchisor's details and business experience
  • lawsuit history 
  • payments to agents 
  • details of existing franchisees 
  • franchise site or territory selection procedures 
  • intellectual property ownership 
  • supply of goods and services to and by franchisees 
  • marketing or other co-operative funds 
  • payments due under the Franchise Agreement 
  • summaries of franchisor's and franchisees' obligations 
  • other material conditions of the agreement; and  
  • financial details and earnings information of the franchisor.

Further obligations may be imposed upon the transfer under the Franchise Agreement (e.g. that a transfer fee be paid.)

In relation to disputes, the Franchising Code of Practice (only applies to members of FANZ), requires that a complaint handling and dispute resolution procedure is included in the Franchise Agreement. This helps facilitate mediation of disputes rather than costly lawsuits.

Franchise Agreements

A "Franchise Agreement" as an agreement where the franchisor grants to another person (the franchisee) the right to carry on the business of offering, goods or service, under a system (or marketing plan) determined by the franchisor.

Essentially, a Franchise Agreement is an agreement granting you a right to operate a business under a system of the Franchisor.  You are associated with its intellectual property and trademarks.  In exchange is the payment of a fee for this right, usually in the form of royalties or service fees.

The Franchise Agreement deals with your relationship with the Franchisor and outlines the rights and obligations of the parties in relation to matters such as:

  • Advertising and promotions 
  • Accounting/reporting obligations 
  • Assignment and sale of business 
  • Dispute resolution procedures 
  • Manuals and policy directives 
  • Default and termination 
  • Guarantee and indemnity

When you are purchasing an existing business the franchise agreement must be entered into in addition to the Agreement for Sale and Purchase of a Business.

Legal Advice

Similarly, with the purchase of a business, professional advice is not only recommended.  In this regard, you would need to have a lawyer experienced in franchising review the Franchise Agreement and Disclosure Document.  This will ensure its compliance with the Franchise Association's Franchising Code of Practice and the Franchising Code of Ethics and to conduct general due diligence of the business and franchise system.  Note that not all franchise systems are members of the Franchise Association and non members aren't bound by these codes. Your lawyer would also be able to provide you with advice in relation to 'structuring' the purchase.

In considering the purchase of either an independent business or a franchised business, it is necessary to consider how to structure the purchase. You need to decide whether you will conduct the business as an independent proprietor, private company or as a partnership.

Depending upon your choice, taxation implications will arise and relevant shareholder or partnership agreements may be required.  It is essential that accounting and legal advice is obtained before entering into the purchase of a business or franchised business to save you further long term costs and stress!

Franchising is a great business model but you need to be aware of your rights and responsibilities.  The normal checks and due diligence that you would apply in starting your own business equally apply in relation to a franchise. So you're ready to buy?  Review the steps to buying a business.