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What Risks Are Involved in Becoming a Franchisee?

What Risks Are Involved in Becoming a Franchisee?

Thinking of becoming a franchisee? Find out the risks associated with owning a franchise.

3rd May 2019
Reading Time: 2 minutes

A franchise is an alternative to starting a unique business. Franchising is a different way of doing business, involving the owner of the franchising business (the ‘franchisor’) giving permission to a person (the ‘franchisee’) to adopt their business name, process, model and marketing for a fixed period of time. A franchisor and franchisee are bound to each other by an agreement granting the rights to carry on offering, supplying or distributing goods or services. While some research shows that franchises are more successful than independent small businesses, there are still many risks.

Franchisees have ongoing obligations to uphold. Franchisees are subject to the Industry Codes under Federal law. The relevant industry code for parties to a franchise agreement is the Franchising Code of Conduct. Franchisees or prospective franchisees should familiarise themselves with the Codes or risk facing penalties. Failing to comply with franchising industry codes could incur up to 300 civil penalty units (approximately $63,000).

Franchise Start-Up Fee

Becoming a franchisee does not guarantee that your business will be successful. This can be quite upsetting, especially after the exuberant start-up fees and other costs invested into opening a franchise. Franchisees can expect to pay approximately between $5000 and $1,000,000 in initial costs in Australia. This figure will depend on many factors such as the size of the business, location and market prominence. Further, the start-up costs can significantly reduce a franchisee’s pay. Not every franchisee will recover the costs associated with their investment during the course of their business’ lifetime.

Ongoing Costs

Apart from an initial fee, franchisees make a big commitment when opening a franchisee as they have to pay ongoing fees. This presents a risk to franchisees who have to consistently keep up with the costs by making profit in their store. Additional costs that are necessary by law or by a franchisor are:

  • franchise renewal fees
  • advertising fees
  • transfer fees
  • employee and management training fees

In addition, franchisees have to pay royalties to the franchisor. Royalties are a specified percentage of your franchises sales that is paid in addition to any other fees.

The costs associated with owning a franchise go beyond the immediate costs of buying the rights to operate under another business’ name. If you are thinking of becoming a franchisee, it is a good idea to consult a franchise lawyer to find the start-up costs and any hidden costs that you might have to pay.

Lack of Autonomy

Becoming a franchisee demands conformity with the franchise business. There is very little independence or freedom to operate differently to the franchisor. In general, the franchisee must follow the business model, marketing and practices of the franchisor. The franchisor usually also determines everything from the store design and the product or service sold, to the employee uniforms. For a franchisee, this means that in the future, they will be restricted creatively. Whereas small business owners are able to change almost anything about their business because they don’t operate as part of a franchise. If you are thinking of becoming a franchisee, it is important to consider whether you can see yourself sticking to another business’ business model without wanting creative control

Conclusion

Franchises present risks to franchisees because of the financial commitment, and lack of independence from the franchisor. However, franchisees receive benefits too. Franchises are usually a developed business with a strong business model, marketing strategies and a well established name and reputation, which could be used to a franchisee’s advantage.

Author
Jenelle Miranda

Jenelle is a legal Intern at Lawpath as part of the Content Team. She is in her third year of a Bachelor of Law and Bachelor of Science (Physics & Astronomy) at Macquarie University.