Buying a slice of a brand

"Problems are more widespread than you think, and franchisors try to create the impression that you're only successful thanks to them. "But my example proves the opposite."

www.stuff.co.nz
September 27, 2004

Buying a slice of a brand
Franchises can be prosperous businesses. Yet the dream of self-employment can become a nightmare. In the first of a two-part series, Kristina Greene looks at what to consider before signing on.
Kristina Greene

Bill Cornelius went from being a successful and satisfied Challenge Realty Group franchisee to a disgruntled LJ Hooker franchise holder when the Australian real estate group took over.

Three years after settling out of court with LJ Hooker, he is the director of his own successful Christchurch business, Cornelius Real Estate – and wants nothing more to do with franchising despite repeated approaches from real estate groups and individuals hoping to sign a contract.

Once ownership had changed, what had been a convenient relationship went wrong. Mr Cornelius said he was put under heavier pressure to perform. Moreover, turnover possibilities changed for the worse as he found the new brand more difficult to market.

LJ Hooker New Zealand could not be reached for comment.

But the harsh reality of a contract is hardly what would-be managers have in mind when researching the market.

Franchising is big business in New Zealand. According to recent surveys, low unemployment figures have made only a small dent in the market and Kiwi businesses still clone themselves faster than anywhere else in the world.

In 2003, franchises and company-owned outlets were up 36 per cent from the previous year, with most new brands starting out franchising before they were a year old. The sector is worth an estimated $6.9 billion.

Little wonder. Kiwis buying into ready-made franchise nests find an answer to their entrepreneurial spirit and also avoid typical worries faced by independent start-ups.

Franchisees benefit from an established brand and tested products, which enable them to hit the ground running. In most cases, they enjoy franchisor support and training, and are often supplied with in-store material. As franchise managers, they gain a strong level of independence, while minimising the risks of self-employment.

Examples abound to show that franchising can be rewarding for both parties, with franchise businesses enjoying a higher success rate than independent small businesses. In ideal situations, contracts stay in the drawer, and both parties enjoy significant advantages.

Figures supplied by the Franchise Association of New Zealand show more than 96 per cent of all new franchises survive their first three years, but, overall, only 60 per cent of new small and micro-businesses remain alive after the same time.

But though FANZ members abide by a code of ethics as well as disclosure and mediation rules, thus keeping their dispute rate at approximately 1 per cent of members, anecdotal evidence shows conflicts between non-member franchisors and franchisees are on the rise.

The association had set up a mediation panel, which is open to non-members as well, in an attempt to reduce tension in the franchising industry.

Bill Cornelius' case is but one example of a relationship that turned sour.

"In franchising systems, franchisees carry all the risk, pay staff and are responsible for the lease. The franchisor faces virtually no risk and seeks to make a maximum of money," he said.

Christchurch pharmacist Keith Elliott belongs to a pool of unhappy former New Zealand Post franchisees. After a dispute over his franchisor's proposal to add a Kiwibank franchise to the business, he had arranged to sell his business to an employee.

NZ Post then terminated his contract and announced a corporate Post Shop would open nearby, thus wiping out Mr Elliott's chances of recovering the initial franchise investment of $50,000 plus the $25,000 he asked in added value.

He argues NZ Post took advantage of commercial information he had to disclose and used this to its advantage.

He sought satisfaction in court –but the judge ruled for NZ Post, leaving Mr Elliott feeling like a "pawn".

Other former NZ Post franchisees in the city, who wish to remain anonymous, "lost everything" when their contracts were terminated without compensation.

Having read about the Elliott case, one lawyer said he was "stunned with the difficulties some franchisees are faced with. I was given a franchise agreement the other day … in it was a note from the franchisor saying 'take this to your solicitor but do not make any changes. If you do you will not be given the franchise. We do not change the agreement'. "

However, the worst agreements were those from overseas, the lawyer said. "Mr Elliott's losses are chickenfeed in comparison."

Peter Woods from the law firm Anthony Harper said franchise agreements "are always in favour of franchisors and can be quite draconian".

Franchise takers would often lose their contract without any compensation or refund – and also found their possibilities of making an independent living limited by contractual restraints on working in the same business after a franchise contract ended.

"Would-be franchisees with strong skills in specific areas should beware of restraint clauses," Mr Woods said. Entrepreneurs might have to abstain from their core livelihood for up to three years.

Negotiating the terms of a contract was usually close to impossible when the franchisor was an established business – however, franchise takers could often amend clauses when the business was young, Mr Woods said.

"The first franchisees often serve as guinea pigs to get contracts right."

According to FANZ chairman Simon Lord, most franchise disputes arise after a misunderstanding of contractual agreements.

"Franchises aren't ordinary commercial relationships – they are ongoing relations with interdependent partners."

Members of FANZ – to which NZ Post and LJ Hooker do not belong – are bound by specific disclosure rules and agree to seek mediation.

"The danger is that individuals lose all objectivity when looking at a form of business they like. They think it's the best thing since sliced bread and fail to inquire properly about the economics," Mr Woods said.

A business model that functioned well in a populated area might not work in a rural environment.

He recommends that people intending to invest in a franchise ask for a franchisor's track record, inquire about the number of franchisees and their locations, and ask for their contact details.

If the franchisor is reluctant to pass on this information, potential franchisees should be concerned.

He warns that financial projections should be greeted with caution – and that it is essential to inquire about additional costs. It is not uncommon for hidden costs to be included in an agreement – such as mandatory contributions to advertisements or buying supplies from the franchisors.

Mr Cornelius was able to shake off restraint clauses in his settlement, and said he was much better off on his own thanks to market knowledge and accurate positioning. His turnover had increased 50 per cent since he became independent.

"Problems are more widespread than you think, and franchisors try to create the impression that you're only successful thanks to them.

"But my example proves the opposite."


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