What is ‘Franchising’?

Franchising allows a business to operate under the established brand of another business. The franchisee can sell franchisor’s products and/or services for a specified period in return for payment to the franchisor. Franchising is very different to other types of business – It can be extremely restrictive. The level of control compared to a business run independently is very different.

 

Pros of ‘Franchising’ as a Franchisee

It is not compulsory for a franchisee to have any previous or related experience to the field before entering the franchise, simply because franchisor is the one who offer extensive and thorough support with training to franchisee to educate and help them to understand the industry and company’s business model which has proven effective.

Franchisee will be privy to knowledge, experience, and industry secrets that the company has accumulated from years of operation. Such support and accumulated knowledge will lead the franchisee to have more chances of success which it basically why people entering the franchise business.

It is also easier for a franchisee to secure a loan for starting a franchise business comparing to securing a loan for starting an independent business.

Franchises already have a recognisable brand and a loyal customer base; it lowers the risk of the business as customers prefer a recognisable brand rather than unknown brand.

So, if you are considering to buy a franchise business, you will be able to share the well-managed infrastructure of the company which allows you having lower supplies costs.

 

Cons of ‘Franchising’ as a Franchisee

However, the advantages always accompany with disadvantages. The franchisor offering such as support and training can restrict franchisee to make creative changes on the business as it is often that the franchisor controls the products or services that franchise sells and where all franchisees must be sourced from.

Many franchisees may find the initial investment for starting a franchise business is too burden, especially when choosing a big-name franchise. There is also ongoing payment to a franchisor as a form of loyalty fees which is typically 4 to 6 percent of the gross sales revenue and makes a reduction to the profit potentially. The royalty fees are varying with different franchises and will be depending on the franchise agreements.

The other big cons about franchise is that there is no guarantee that a franchisee is able to renew the franchise agreement when the contract is close to expire; as it is purely up to franchisor’s decision unless specifically negotiated under the agreement.

 

 

Governing Legislations and Regulations

All franchise participants, including franchisors and franchisees, must comply with the mandatory industry ‘Franchising Code of Conduct (The ‘Code’)’. The ‘Code’ regulates actions of franchising participants. It aims to ensure that each franchisee is properly informed about a franchise agreement before they enter it. It also provides a cost-effective dispute resolution scheme for franchisees and franchisors.

 

The ‘Code’ provides details as a franchisee such as:

  1. Minimum rights and obligations
  2. The information franchisor must disclose to you
  3. What elements a franchise agreement must contain
  4. A mediation process for disputes.

 

The ‘Code’ applies to a ‘franchise agreement’ which satisfied followings:

  1. An agreement between the parties, which may be written, oral or implied.
  2. One party (the franchisor) grants to another party (the franchisee) the right to carry on a business under a system or marketing plan substantially determined, controlled or suggested by the franchisor or an associate of the franchisor
  3. the business is substantially or materially associated with a specified trademark, advertising or commercial symbol
  4. before starting the business, the franchisee must pay, or agree to pay, an amount to the franchisor or its associate.

Note: if an agreement meets this definition, it will be covered by the ‘Code’ regardless of whether the agreement or business opportunity is referred to as a ‘franchise’ or not.

 

Rights and Responsibility

  1. Disclosure

A franchisor is under obligation to provide specific documents to a prospective franchisee upfront to help him/her make an informed decision about whether to proceed with the franchise.

Prospective franchisees have right to receive four key documents when they are contemplating to buy a franchise:

  1. Information statement
  2. Disclosure document
  3. A copy of the franchise agreement
  4. A copy of the ‘Code’

 

1.1 Acquiring ‘Information statement’

If a person contacts a franchisor to formally apply, or express an interest in, acquiring a franchised business (not about renewing or extending an existing agreement), the franchisor must provide him/her with an information statement. The information statement is a 2-page document that highlights some of the risks and rewards of franchising.

 

1.2 Acquiring other three documents

If a person decides to become a franchisee, the franchisor must also provide him/her with a disclosure document, franchise agreement and a copy of the Code at least 14 days before the person have enter into an agreement or make a non-refundable payment.

The franchisor must also follow this process to their existing franchisee who is planning to renew or extend the agreement, or enter into a new agreement.

If a person is to be required to enter into other agreements as a condition of a franchise agreement—such as a hire purchase, security or confidentiality agreement, or a restraint of trade agreement—these agreements must be provided to him/her at least 14 days before they sign the franchise agreement. If the documents are not available at that time, these must be provided as soon when its available.

 

  1. Good faith

A franchisor and a franchisee are required to act in good faith in its business dealings with each other.

Good faith requires that parties exercise their power reasonably and not arbitrarily or for some irrelevant purpose. Conduct may lack good faith if a party acts dishonestly, for an ulterior motive or in a way that undermines or denies the other party the benefits of the franchise agreement.

However, it does not mean that they should act in the other party’s interest. They are not prohibited from acting in their own legitimate commercial interests. For example, while good faith will require parties to act honestly and cooperatively during the negotiation of a franchise agreement, it is unlikely to compel a franchisor to make any requested changes to the agreement.

 

2.1 Scope of Good faith

The Good faith covers any matters arising in connection with a franchise agreement or the ‘Code’ which means it covers entire aspects of the franchising relationship such as pre-contractual negotiations, performance of the contract, dispute resolution and even after the end (including termination) of an agreement.

 

2.2 Possible breach of Good faith examples

  1. a franchisor treating a franchisee differently because the franchisee has raised concerns about the system
  2. a franchisor raising numerous minor and immaterial breaches with a franchisee in an aggressive and intimidatory manner designed to extract concessions or cessation of complaints
  3. franchisees using confidential information provided by the franchisor to compete with the franchisor
  4. franchisees using social media to post negative comments about their franchisor or their dispute with their franchisor.

 

  1. Cooling off period

It applies to new franchisees only, not in the case of renewals, extensions or transfers of existing franchises. It allows all new franchisees have an opportunity to void the franchise agreement within seven days from the date of signing or paying any fee to franchisor. Once the cooling off notified, the franchisor is obliged to refund all the franchisee’s payments made under the agreement within 14 days upon receipt of the notice. However, the franchisor is permitted to retain reasonable costs incurred such as general expenses from legal fees for drafting the agreement, training costs and administrative costs in recruiting the franchisee. The amount of the reasonable costs is varied according to the provisions about the cooling off period in the agreement.

 

Franchise Tax obligation

There are different tax obligations for franchisees and franchisors.

 

Franchisees

Franchisees can operate the businesses as different business structures, so their taxation obligations. They may be eligible for deductions from ongoing franchise fees. Other deductions may also be available for payment of training fees and loan interest from your taxable income.

Capital Gain Taxes (CGT) and Goods and Service Tax (GST) may be imposed when they buy, sell, transfer or terminate the franchise.

 

Franchisors

It is important for franchisors to understand their tax obligations and how franchising fees are treated for tax purposes. Specifically, income tax and goods and services tax (GST) are likely to impose them to reporting requirements. In general, every payment made from franchisees will be subject to income tax and GST.