I’m Buying an Existing Franchise Business – What Due Diligence Should I Undertake?

Buying an existing franchise can be a great opportunity, but you need to do your own due diligence. Don’t just rely on what the vendor, agent, or even the franchisor tells you. Their interests may not align with yours. Thorough checks will help you make the right decision and avoid costly mistakes. Here are seven essential steps to follow.

1. Review the Franchise Agreement

The Franchise Agreement outlines your rights and obligations. Read it carefully. Pay close attention to:

  • Term and Renewal: If the franchise has a 10-year term and you’re buying in its 7th year, you may only have 3 years left unless the franchisor agrees to renew. You should confirm whether the agreement allows for renewal, and if so, under what conditions.
  • Refit Requirements: Some agreements require franchisees to refurbish the premises or upgrade equipment at set intervals. If a refit is due in year 5 and you’re buying in year 4, you must factor this into your budget.
  • Legal Review: A franchise lawyer can review the agreement to identify unfair terms, hidden liabilities, or excessive restrictions. They can also clarify key obligations, such as franchise fees, marketing contributions, and your rights if you want to sell the business in the future.

2. Review the Lease

If the business operates from a leased premises, the lease agreement is just as important as the Franchise Agreement. Make sure you understand:

  • Lease Term & Renewals: The lease should ideally match the franchise term to avoid the risk of losing the premises before your agreement ends.
  • Assignment Conditions: Many leases require landlord approval before you can take over. Ensure all necessary steps are completed to avoid delays.
  • Rent and Costs: Check not just the current rent but also any scheduled increases, outgoings, or maintenance obligations that could impact your profitability.
  • Personal Guarantees: Some leases require personal guarantees, meaning you could be personally liable if the business fails. A franchise lawyer can help negotiate these terms where possible.

3. Review the Accounts

A business’s financial health is critical. A deep dive into financial records helps reveal any issues. Check:

  • Bookkeeping Data: Reviewing daily financial records helps assess real cash flow trends and operational costs.
  • Banking Records: Bank statements can verify revenue figures and expose any inconsistencies in reported income.
  • Profit and Loss Statements: These should be assessed over multiple years to identify trends or irregularities.
  • Engage an Accountant: A professional accountant can help interpret financials, assess risks, and identify any areas that need further clarification.

4. Ensure the Assets Are Free from Encumbrances

If you are acquiring assets such as equipment, stock, or vehicles, ensure they are free from debt or other claims. Conduct a Personal Property Securities Register (PPSR) search to confirm:

  • The vendor owns the assets outright and has the legal right to sell them.
  • No outstanding loans or security interests are registered against the assets.
  • You won’t inherit liabilities tied to business equipment or inventory.

5. Talk to the Employees

Employees are critical to the business’s success. Speaking with them can provide insights into:

  • Workplace Culture: High staff turnover or low morale can indicate management or operational issues.
  • Skills & Experience: Understanding staff capabilities helps assess training needs and potential disruptions.
  • Employment Contracts: Review contracts to ensure compliance with workplace laws and confirm whether existing employees will transfer with the sale.
  • Wages and Entitlements: Check for any outstanding leave entitlements, superannuation obligations, or potential underpayment issues that could become your responsibility.

6. Look at Online Reviews

Customer feedback can tell you a lot about the business’s reputation and potential risks. Check:

  • Google Reviews & Social Media: Look for common complaints, recurring issues, or customer praise.
  • Franchisee Forums & Industry Groups: Other franchisees can provide insight into how the franchisor operates and whether there are widespread concerns.
  • Customer Trends: Identify patterns that may impact business performance, such as seasonal demand fluctuations or shifting consumer preferences.

7. Inspect the Premises, Equipment, and Fitout

A physical inspection helps uncover any issues that could lead to unexpected costs. Check:

  • Premises Condition: Ensure the location is well-maintained and complies with lease obligations.
  • Equipment & Fitout: Confirm that all equipment is operational, meets safety standards, and is included in the sale.
  • Compliance Requirements: Check if any equipment or premises modifications are needed to comply with industry regulations or health and safety standards.
  • Required Upgrades: Identify any pending refurbishments or repair costs that may arise soon after purchase.

Final Thoughts

Buying an existing franchise can be a smart investment, but only if you conduct thorough due diligence. A franchise lawyer can help navigate the legal complexities, while an accountant can ensure the financials stack up. By carefully reviewing the franchise agreement, lease, financial records, and operational aspects, you can enter the purchase with confidence and protect your investment.

 

Disclaimer: This article contains general information only and does not constitute legal advice. Magnolia Legal disclaims any liability arising from reliance on this article. Our terms of use apply