The allure of owning a franchise can be irresistible. Imagine inheriting a blueprint for success and riding on the coat tails of an established brand. It sounds ideal. But as recent news, like the Horizon Post Office scandal, has shown, the waters of franchising are murkier than they appear.
By Christine Rolland, Forensic Accountant, Henderson Loggie
Having been involved in various franchise disputes as a forensic accountant, I’ve observed common pitfalls that budding franchisees might face. Here’s what you need to know before signing on.
Understand exactly what you’re committing to
First off, do you really know what you’re signing up for? It’s a common scenario: the franchisee’s vision of the agreement does not align with the reality of the written contract.
If you’re considering a franchise, especially in retail sectors like coffee shops, know your boundaries. Are you allowed to sell products outside of those stipulated by your franchisor, like greeting cards and gifts, or must you stick strictly to coffee and pastries? Misunderstandings here can lead to serious conflicts. A clear grasp of what business you’re really in and what’s out of bounds can save you from significant headaches down the road.
Entering into a franchise agreement isn’t just about blindly accepting what’s presented to you; it’s about completely understanding the terms so that you can protect your interests and ensure business viability.
Understand your supply obligations
A key element that often gets overlooked is where your products come from. Many franchise agreements require that you source exclusively from the franchisor. Diverging from this can lead to severe penalties, a costly mistake you want to avoid.
For instance, in one engineering franchise dispute I handled, the franchisee thought they could buy certain products from third-party vendors because the “product list” wasn’t finalised at the time of signing. This led to a major legal tussle.
Clarify responsibilities
Clear definition of responsibilities is essential. Who is handling the accounts? What about IT and systems management? If something goes wrong in these areas, knowing whether it’s your responsibility or the franchisor’s can mean the difference between a quick fix and a drawn-out dispute. Transparency in who is responsible for what reduces the risk of conflicts and ensures smoother operations within your franchise business.
Navigate pricing pitfalls
When you’re stepping into a franchise, one of the crucial aspects to understand is how the franchisor sets the prices of the products they sell to you. It’s usually detailed in the franchise agreement, but the specifics can sometimes be overlooked until it’s too late. You don’t want to be stuck purchasing goods at steep markups that eat into your profits.
Typically, franchise agreements will specify a percentage markup on goods supplied to franchisees. This is supposed to keep pricing fair and predictable.
However, real-world scenarios can lead to disputes and financial strain. For example, I once dealt with a case in the fast food sector where both the franchisor and franchisee were relatively green in franchise management. They had an agreement in place that capped the markup on goods sold to the franchisee, but a major issue arose: the franchisor had only a vague idea of the actual costs of the products.
This lack of detailed costings led to allegations of exorbitant pricing. We had to spend significant resources –sifting through boxes of invoices and manually pricing out handwritten recipes – to prove that the markups were within agreed limits. This not only demonstrated the importance of having detailed cost breakdowns from the get-go but also highlighted how critical it is for you, as a franchisee, to ensure such details are iron-clad before signing the agreement.
Plan your exit
Finally, what if things don’t work out? Understanding your escape routes is crucial. Exiting a franchise agreement can be as complex as entering one. What are the financial repercussions of terminating your contract early? Often, you might have to not only pay the remaining franchise fees but also compensate the franchisor for lost profits. Knowing the terms for early termination – how penalties are calculated and over what time period – can help you assess the risk and plan accordingly.
Franchising can offer incredible opportunities, but it also comes with its fair share of challenges. By understanding your terms entirely, staying informed about your responsibilities, planning exit strategies, and leveraging the experiences of fellow franchisees, you can establish a strong foundation for a successful business.
Being well-informed and prepared can make all the difference in turning your franchising venture from a potential headache into a profitable, enjoyable business.
christine.rolland@hlca.co.uk
www.hlca.co.uk
Posted: 7th June, 2024