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Before you buy in
A franchise can be a proven pathway to business ownership. But like any significant investment, it demands careful due diligence before you commit.
Why franchising works
Franchising can be a great business option because while it is not without risk, the franchisor relies on your success to reap its own rewards. This means they are incentivised to help you succeed.
You get a proven business model, established brand recognition, training, and ongoing support. In return, you pay for the right to operate under their system and follow their processes.
However, like any business venture, it is crucial to approach franchising with careful consideration and thorough due diligence. Here are five key areas to evaluate before you sign.
5 things to consider before buying
Which industry should I enter?
Choosing an industry that complements your professional experience and your general strengths and weaknesses is advisable. However, not having experience in an industry does not necessarily mean you should rule it out.
You do not necessarily have to have worked in a pizzeria to be able to run a pizza franchise successfully. Your attitude and determination are often more important when it comes to achieving the best results in a franchise business.
Key question: Do your skills, personality, and lifestyle suit this type of business? Talk to existing franchisees about what the day-to-day reality looks like.
What are the setup costs?
Franchises come in a vast range of types and sizes. They can cost anywhere between a few thousand and several million dollars to buy. Whatever your budget is, ensure you know exactly what the setup costs are and what is included.
A franchise fee will normally cover the rights to use the brand and systems. Some other things it may include are:
Do not forget: Account for other costs you may need, such as accountants, lawyers, and any other professional advisers. These should be factored into your total startup budget.
What are the ongoing fees?
All franchises require their franchisees to pay ongoing fees, sometimes called royalties, management fees, or licence fees. These can come in the form of:
Flat fee
A fixed amount regardless of turnover
Percentage of turnover
Scales with your revenue
Product markup
Built into required product purchases
Service fees
Specific charges for technology, marketing, etc.
Key question: Ensure you find out what all the fees are so you can accurately project your true cost of operating the franchise over its term.
How are sales projections calculated?
Unlike projecting costs, franchisors cannot know what sales you will achieve with certainty as there are too many variables, including your own performance. Find out how any sales projections were calculated so you know how much reliance you can place in them when making a decision to purchase.
Questions to ask about projections:
- Were sales projections based on existing franchise sales?
- Is your territory comparable to others in the network?
- Are the projections based on NZ outlets or international data?
- Can you verify the numbers with existing franchisees?
Are you financially prepared?
Ensure you account for not just the costs related to buying and running the franchise, but other costs such as your tax obligations and any finance costs.
Payroll vs Drawings
How will you pay yourself?
Tax Deductions
What can you claim?
Finance Costs
Loan interest and repayments
Critical: Work with an accountant to model realistic cash flow projections, including the time it takes for a new business to reach profitability.
Why you need a lawyer on your side
The franchise agreement and disclosure documents are prepared by the franchisor, to protect the franchisor. They are rarely negotiable on major terms, but that makes understanding what you are agreeing to even more important.
An experienced commercial lawyer can identify red flags, explain what the terms actually mean for your day-to-day operations, and help you understand your rights and obligations over the life of the franchise.
What we review for franchisees:
Key Takeaways
Choose an industry that suits your skills and personality, not just your budget
Understand the full setup costs, including professional advisers
Calculate the true ongoing cost including all fees and levies
Verify sales projections with existing franchisees where possible
Ensure you have adequate working capital beyond the purchase price
Get independent legal advice before signing anything
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