Australia: Are you doing your due diligence when buying your business?

Buying a business, whether it be a franchise or not, is a huge investment for most people. With the huge financial and emotional investment required to operate a business, it always surprises me when new business owners (including franchisees) are unaware of what due diligence is and how it affects the consideration of their business venture.

In legalese, due diligence is the extensive appraisal of a business or franchise undertaken by a prospective buyer. A due diligence audit will reveal the following information:

  • Current assets and liabilities;
  • Current leasing arrangements;
  • Current and prospective litigation matters; and,
  • Current employee arrangements and contracts.

Given the level of insight due diligence provides, it's concerning that prospective franchisees are uncomfortable with the process. Instead of viewing due diligence as an expense to the business, franchisees should view the process as an investment, as it provides critical knowledge required to make a calculated decision.

Failing to audit a business deprives a franchisee of the opportunity to consider if their purchase is good value for money, if they are equipped to combat inherent challenges faced by the business and if the business model meets their expectations.

Starting the due diligence process can often be daunting and difficult. Below are my do's and don't's to help facilitate this process:

What you need to do before you buy a franchise

  1. Check upfront and continuing fees

In relation to the franchise agreement, it's normal practice for a franchisor to charge a franchisee an array of upfront fees including a trade mark application fee, training fees and the initial franchise fee, on execution of the franchise agreement. You should ask the franchisor what upfront fees you will be expected to pay and what continuing fees you must pay in the future.

  1. Review the disclosure document and franchise agreement carefully>

You should read both documents thoroughly and in the process of doing so, make a list of the queries that occur to you. These could be questions s for the franchisor, your accountant or for your lawyer.

  1. Do your background research

You should use the internet to find out as much background information as you can about the franchise. The internet can equip you with information that isn't necessarily required to be disclosed in the disclosure document or franchise agreement.

For example, you may discover that the franchisor may have pending mediation with a large number of other franchisees. Keep in mind that the internet can be a highly unreliable source of information but it may help you to add questions to your list.

  1. Involve your business advisory team as soon as possible

My experience has been that it is in your interest to involve your accountant as well as your solicitor early in the transaction so that you begin negotiations with the franchisor knowing the full implications of the relevant contractual and taxation obligations imposed on you.

  1. Get the structure right and have your finances in order

You should consult with an accountant experienced in assessing franchise businesses to discuss the feasibility of the particular franchise and to discuss the most appropriate business structure to establish as the franchisee entity. Your accountant will consider taxation obligations and asset protection strategies, as well as ensuring that you are able to access required finances to help fund the acquisition.

  1. Contact existing franchisees

You should make a list of questions to pose to existing franchisees about the performance of the franchisor and the franchise. Contact them and ask your questions, either over the phone or, better still, in person. There will be a list of the current franchisees included in the disclosure document.

Don't do these things when you buy a franchise

  1. Rely on 'handshake deals'

Buying a business is a very exciting time. I often see my clients very keen to get started and as a result they tend to rush the process and dive straight in.

With this frantic mindset, you're less likely to ensure that all promises, obligations, rights or responsibilities are properly documented. This can pose a number of challenges later on when you go to rely on the word of the franchisor and they renege or don't remember the conversation.

  1. Sign a lease until you've been approved as a franchisee and you have received finance

When negotiating the terms of purchasing a business, you must ensure that you try to arrange for the start of the lease and franchise agreement to occur roughly at the same time.

Failing to do so may result in having to pay rent for a couple of months before you can start trading in the new business. You also want to ensure that once you've ironed out all terms of the leasing and franchise agreement deal, you are approved for finance.

Again, you don't want to see yourself out of pocket for a couple of months before your finance can get sorted.

  1. Don't underestimate expenses and initial capital required

In the process of organising their finances and budgeting furiously, my clients often underestimate or forget to include additional amounts of money required to cover expenses. These additional expenses range from employee expenses such as leave entitlements, uniform and equipment costs, insurances and training expenses and just day-to-day operating costs. I suggest having a buffer when it comes to your budget so as to leave you with some room to breathe.

Three things to remember about due diligence

  • You're entitled to request it: it is commercially sensible to ask as many relevant questions about the business/franchise before buying;
  • Help is available: you aren't expected to understand every piece of information due diligence provides, nor are you supposed to forecast the potential ramifications stemming from this knowledge. Professional advice is available to help you make sense of the documentation; and,
  • It's an investment not a cost: while due diligence may require your time, the advice of professionals and financial costs, the overall benefits of the process far outweigh the short term costs.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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