FRANCHISING - AN INTRODUCTION FOR PROSPECTIVE FRANCHISORS

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1 FRANCHISING - AN INTRODUCTION FOR PROSPECTIVE FRANCHISORS ABOUT This guide assists businesses considering using a franchise system as a distribution channel. The guide broadly covers the issues which must be considered before franchising. This guide is not intended to be exhaustive and Franchise Legal recommend that prospective franchisors obtain professional advice from advisors and experts in franchising. 1. FRANCHISING IN AUSTRALIA Franchising is regulated by the Trade Practices (Industry Codes - Franchising) Regulations 1998 ( Code ) which is a code of conduct, prescribed pursuant to Section 51AE the Competition and Consumer Act 2010 ( Act ). Section 51AD of the Act states that a corporation must not, in trade or commerce, contravene an applicable industry code. The conduct of both franchisors and franchisees is subject to the Code. The Australian Competition and Consumer Commission ( ACCC ) is the government agency responsible for promoting compliance with the Code. The Franchise Council of Australia Limited ( FCA ) is the main association within the franchise sector in Australia. 2. THE FRANCHISE BUSINESS MODEL Franchising is a distribution channel for goods and services. It can be an efficient manner in which to grow your business by including sufficiently motivated operators to maintain the standards required to operate the business What is a Franchise Agreement? In Australia a Franchise Agreement is defined in the Franchising Code of Conduct ( the Code ) as an agreement that takes the form, in whole or part, of any of the following: a written agreement; an oral agreement; an implied agreement; and in which a person (the franchisor) grants to another person (the franchisee) the right to carry on the business of offering, supplying or distributing goods or services in Australia under a system or marketing plan Introduction for Prospective Franchisor Franchise Legal Page 1 of 6

2 substantially determined, controlled or suggested by the franchisor or an associate of the franchisor; and under which the operation of the business will be substantially or materially associated with a trade mark, advertising or a commercial symbol: owned, used or licensed by the franchisor or an associate of the franchisor; or specified by the franchisor or an associate or the franchisor; and under which, before starting business or continuing the business, the franchisee must pay or agree to pay to the franchisor or an associate of the franchisor an amount including, for example: an initial capital investment fee; or a payment for goods or services; or a fee based on a percentage of gross or net income whether or not called a royalty or franchise service fee; or a training fee or training school fee; but excluding: payment for goods and services at or below their usual wholesale price; or repayment by the franchisee of a loan from the franchisor; or payment of the usual wholesale price for goods taken on consignment; or payment of market value for purchase or lease of real property, fixtures, equipment or supplies needed to start business or to continue business under the franchise agreement. (2) 2.2. For the definition of Franchising above, each of the following is taken to be a franchise agreement: a transfer, renewal or extension of a franchise agreement; a motor vehicle dealership agreement None of following constitute a franchise agreement: an employer and employee relationship; a partnership relationship; a landlord and tenant relationship; a mortgagor and mortgagee relationship; a lender and borrower relationship; the relationship between the members of a cooperative that is registered, incorporated or formed under any of the following laws: (i) Co-operatives Act 1992 of New South Wales; (ii) Co-operatives Act 1996 of Victoria; (iii) Cooperatives Act 1997 of Queensland; (iv) Co-operative and Provident Societies Act 1903 of Western Australia; (v) Co-operatives Act 1997 of South Australia; (vi) Co-operative Industrial Societies Act 1928 of Tasmania; (vii) Cooperative Societies Act 1939 of the Australian Capital Territory; (viii) Co-operatives Act 1997 of the Northern Territory; (ix) the Corporations Law. Introduction for Prospective Franchisor Franchise Legal Page 2 of 6

3 A franchise is succinctly described as the grant by one party, (the franchisor) to another party (the franchisee) of the right to carry on a business under a particular name or trade mark according to an identified system, usually within the territory or at a location and for an agreed term. 3. TYPES OF FRANCHISES Franchising has been effectively implemented in several different business relationships The Business Format Franchise Under this model, a franchisor uses a network of franchisees to market a service or product under a common name and standardised system. This system is prevalent in Australia amongst major food chains and standard service providers. The key feature of such franchises, is the provision of a comprehensive system in which the franchisee has the benefit of being granted the right to use the full system, including the brand, manuals, procedures, marketing programs, quality assurance systems, and the franchisor provides training and support services to franchisees. From a franchisor s perspective, standardisation, consistency and uniformity across all aspects of the chain are essential to this format of franchise. Consider how for example McDonald s burgers taste the same throughout Australia. In this system it is important to note that the franchisee will rely heavily on the expertise of the franchisor as the franchisor maintains significant control over the scope of activities the franchisee may undertake within the franchise Agency Arrangements Under this format agents provide products and services on behalf of the franchisor to the franchisor's customers. Examples include Australiapost post offices, banks and car rental companies. These arrangements often do or do not fall within the definition of a Franchise Agreement under the Code and it is important to analyse the specific set of facts to ascertain if the particular arrangement is a franchise or not Dealer Relationship Under this format franchisees may be granted the right to distribute a manufacturer's product within a specified territory or at a specific location, generally with the use of the manufacturer's identifying name or trademark, in exchange for fees or royalties. A prime example is in the motor vehicle industry, mobile phones (e.g. Optus shops) and business equipment stores Distributorship Under this format the franchisee acts as a wholesaler of the franchisor's products within a defined territory. To satisfy the definition of a franchise the grant must accompany the right to use a trade mark or name. A common occurrence of this model would be in computer software, petrol distribution, food services, confectionery, and building industries Licensing or Manufacturing Franchise Under this format the franchisor grants a licensee/franchisee the right to use certain technology or knowledge to manufacture and distribute the franchisor's product. This format does not apply to a business model and is a common distribution channel in the information technology industry, soft drink, cosmetics and automotive industries 4. THE ADVANTAGES OF FRANCHISING 4.1. Franchising is a rapidly expanding feature of the Australian small business sector because of the beneficial prospects it offers Franchisors, including: Introduction for Prospective Franchisor Franchise Legal Page 3 of 6

4 The negation of the need for capital to expand by leveraging the access to the resources of individual franchisees; Rapid, less complex market penetration; The potential to gain market share; Shared risk with Franchisees; Potentially higher return on investment; Engagement of other highly motivated owner-operators who have a real stake in the success of the franchised business; Greater reach of brands in locations where franchisees possess local industry knowledge and access; A switch form middle management to owner-operators; Increased marketing and buying power; and Ability to provide ongoing product and systems development. 5. SEEKING THE RIGHT ADVICE 5.1. The Right Legal Advice Franchising is a distribution model and it is important to note that this model requires a unique system created for the particular business to be franchised, and is distinguishable from a form of marketing Often businesses do themselves harm by choosing to franchise a successful small operation. In Australia for example the large geographical size drives a lot of small businesses to consider franchising as a method to ensure growth, because it is hard to manage multi-site company owned operation over all the states and territories. Franchising can risk the existence of the very business itself and it is not uncommon to see entire businesses fail on account of choosing to franchise The planning and analysis undertaken at the commencement of the exercise will play a crucial part in the success or failure of the franchise network As legal advisors, we see our role is to ensure that the client understands the risks involved and provide the client with a risk-appraisal and risk-management strategy. A good legal advisor will possess a solid commercial understanding of the business and be able to appreciate how market forces can affect the business Is the Business Franchiseable? The first stage of preparation is to assess whether the existing business is, in fact, able to be franchised. This is largely determined by evaluating the market in which the business operates and assessing the ability to establish successful clone operations in other locations. In making such an assessment, it is necessary to understand the reasons for the success of the existing business so that the same criteria can be sought for each franchised location. It cannot be underestimated that even with the best intentions by everyone involved, a small business can perform very well in one location, but fail in another It is in the prospective franchisor s interest to conduct a sufficiently detailed analysis of the existing business in order to understand the ingredients which are responsible for the success of the business and make a knowledgeable forecast of the potential for franchising. The lawyer s role includes the analysis of the client s intellectual property and the Introduction for Prospective Franchisor Franchise Legal Page 4 of 6

5 ability to protect it throughout the region(s) in which the franchisor wishes to operate the proposed system. A worldwide or country-targeted searches may be appropriate if international franchising is, in fact, considered Developing the Franchise Once the above steps have been completed, the franchisor should then work on the operational model of the system. This process involves the creation of workflow and the separation of duties between the franchisor and franchisees Financial modelling If the business is one which has the potential of being franchised, it is essential to create a financial model, having regard to both parties which will make up the whole of the business: the franchisor and the franchisee Even if the business can be successful in another location, it is necessary to establish that the franchisee, after paying the franchisor all fees pursuant to the franchise, will still receive an acceptable return on investment. Similarly, the franchisor must establish that the franchisor s business (quite separately from the operation of the existing business) will become profitable after the introduction into the system of a certain number of franchisees It is important to ensure that the break-even number of franchisees is realistic as the franchisor will continue to be bound by its obligations to develop the network and provide services to franchisees for the duration of the agreement regardless of the number of franchisees in the system Operations Manual The Operations Manual is a crucial part of the offering to franchisees. It is the operational bible of the business and must be so comprehensive that it should cover all aspects of running the franchisee s business The Operations Manual should include references and guides relating to any relevant legislative requirements of the business, such as occupational health and safety, employment laws, any licences or permits required to operate and the franchisor s recommended manner of dealing with such matters Territory/Site Depending on whether the franchise is in respect of a mobile or retail business, the franchisor must determine whether the franchise is being granted for a territory or a specific site It is important that in determining potential franchise locations and/or mapping territories, the Franchisor rely on sound demographic evidence which is not only consistent with the franchise model but also provides a large enough market for each franchisee For some franchises, particularly mobile, it may be appropriate to provide that the franchisor may sub-divide a territory in the event that the franchisee s revenue exceeds an agreed amount and the franchisee is unable or unwilling to further service the demand in his or her territory Supply arrangements It is tempting for a franchisor to create additional income streams from the franchisee group of businesses. However, such arrangements may be in breach of the exclusive dealing or other provisions of the Competition and Consumer Act Commercially, one of the benefits of becoming part of a franchise group is the buying power which the system offers to each participant. This does not mean that the franchisor may not benefit at all from negotiating group prices. What is essential is that the franchisor does not benefit at the franchisee s expense. Introduction for Prospective Franchisor Franchise Legal Page 5 of 6

6 Some arrangements, like third line forcing are forbidden outright by the Act, others breach the Act only if they substantially lessen competition. It may be prudent to submit a notification to the ACCC in respect of a proposed supply arrangement Franchise Agreement Contact Us Franchise Legal info@franchiselegal.com.au It is, of course, the lawyer s role to correctly record commercial terms and the parties obligations in the franchise agreement which is, ultimately, the single most important document and the result of the initial set-up project The agreement should also incorporate the terms of the Manual and allow the franchisor to amend the Manual from time to time. NEXT STEPS: For an obligation-free discussion about your franchise plans, contact one of our lawyers in Melbourne, Sydney or Brisbane today on Introduction for Prospective Franchisor Franchise Legal Page 6 of 6