Buying into a franchised business is a common approach to self-employment. You generally get good support from the franchisor and wider franchise network, you don’t need to focus on every detail when setting up and running the business, and you generally know the business model is a proven success. The risk is often lower than buying and running an independent business. But franchises are not for everyone. Some franchisees complain that their business is constrained by the rules of the franchise. Others complain that the franchise fees are too high. In this article, I am going to provide a general overview of franchise systems in New Zealand, focusing on the potential upsides and downsides, and features to look out for when considering a franchise business.
I have had quite a bit of involvement with franchise systems with franchisors, franchisees, and potential buyers. When I was a broker in Auckland, I worked with some primary and master franchisors and looked at their franchise systems. I have also worked with people looking to grow their businesses by developing a new franchise system.
First, let’s deal with some of the terminology. If you are new to franchises, the terms used might be confusing.
What is a Franchise?
The term franchise gets thrown about in various contexts, often without real definition or meaning. So I am putting a stake in the ground for our purposes here. Franchising is a business model in which the franchisor grants others (franchisees) the right to use the franchisor’s Intellectual Property (IP) in their own business. This IP can include the franchisor’s brand name and trademarks, patents, business systems, supplier agreements, and training. In return, the franchisee pays the franchisor for this IP. This payment can be made up of an initial fee, ongoing royalties, margin on goods supplied, and so on. In some cases, the franchisor may also take a shareholding stake in the business, and also be the landlord. The rights and costs are set out in the franchise agreement.
In most cases, a specific owner/franchisee will have a defined franchise territory. This territory is typically defined by geography so that the franchisee is ‘buying’ a tangible customer base or catchment area. Most franchising tries to minimise overlap or competition between franchisees, but there are many exceptions to this approach. Some of these exceptions are discussed later.
Franchisees and Franchisors
You should think of the franchisee as a customer of the franchisor. Franchisees run their own businesses. Each is an independent, limited liability business. The franchisee agrees to operate their business as per the rules set out in the franchise agreement.
Franchises often operate in a hierarchical structure. Many of the franchise businesses in New Zealand are ultimately owned and headquartered overseas. In these cases, New Zealand might be made up of one or more franchise territories, each run by different master franchisors, who then sub-franchise within that territory to the ultimate business owner operator, the franchisee. A master franchisor may also run one or more of the franchise businesses within their territory.
The key role of the master franchisor is to develop the franchise within their territory. They will also have a franchise-like agreement with the next level up in their franchise hierarchy, giving them (typically exclusive) rights to the franchise system in their assigned territory. At the top of this pyramid is the primary franchisor.
With the growth of home-grown franchises, franchisees are increasingly dealing with a local primary franchisor, who also acts as a master franchisor: developing and managing the franchise system.
Franchise Systems
The term franchise system refers to a specific franchise model. There are a wide variety of approaches to franchising, but once the originator of the franchise business settles on a successful model, that is what gets replicated as the franchise system, codified in the franchise agreement. This isn’t to say that the way a franchise works doesn’t change, but in most cases, a master franchisor will want to duplicate the successful model when they sell a new franchise territory.
Franchise systems tend to be very well defined and prescriptive on franchisees. In many cases, this limitation on the scope of each business may be defined in the master franchise agreement. The primary franchiser often seeks a single, global standard for their brand. The master franchisor and the franchisee may have some limited scope to localise the franchise system to their markets.
Buying Into A Franchise
There are two ways you can buy into a franchise system. First, you could buy an existing franchise territory of an existing franchisee. This is essentially the same as buying any business, but does require you to be aware of the rules of that system. The other approach is to buy a ‘greenfield’ territory – a territory where no existing franchisee currently operates. A greenfield territory may be recycled, meaning that a franchisee has operated in that area before, but has since shut down; split, where a single territory is split into multiple territories; or original, where the franchise business has never operated. Each of these greenfield approaches comes with benefits and drawbacks, the key drawback being that there is no immediate cash flow being generated from that territory.
What Are You Getting Yourself Into?
A franchise system can be worthwhile for a franchisee for a range of reasons. Not all will apply to every franchise system, or to every franchisee. The reference point here is comparing owning a franchise business versus owning an independent business (i.e., one that isn’t part of a franchise).
Access to a proven business model is typically the biggest benefit. Starting a business is difficult. Getting the internal processes and systems right is also hard. Many new businesses fail due to the owner lacking the right understanding of how their business should operate. With a franchise, you jump over this phase. The first generation of franchisees and founders have already debugged the business model. A key caution here, though, is that the franchise system needs to be operating successfully in your geography to see these benefits. Just because a business model works in the US does not guarantee success in New Zealand. For example, the suppliers (and supply chain) may be different, the cost structures may be very different, and labour rules and awards may limit the applicability of the business model.
In most cases, you are getting access to an established brand. From day one, you will enjoy brand recognition and lower costs associated with brand development. This typically speeds up your initial growth compared to developing and launching your own independent brand. But this is not always the case. The brand may be unknown (or very new) in your geography. Where this is the case, you may have many of the same start-up branding challenges, although potentially that burden is shared across all the franchisees.
Similarly, coordinated marketing and advertising using larger agencies can give your business marketing clout beyond that of an independent firm, while also taking this load off your plate. Many small business owners lack the right skills to run their own marketing efforts and also don’t have the experience to manage an external provider. Keep in mind that the franchisor will tend to run national campaigns focused on the brand and standard offerings. To embed yourself in your local community, you may still need to undertake some marketing on your own or pay the franchisor to do this for you.
Your franchise system should provide your online presence. This should include a branded website that forwards referrals in your territory to you (at no additional or per-referral charges). This may also include an effective e-commerce platform or booking system (calendar). The franchisor’s marketing team may also run branded pages on Facebook, Instagram, and LinkedIn, and channels on video platforms like TikTok and YouTube. This should include regular content updates across these social platforms. The franchisor may also provide more customised offerings for your territory, such as placing your business on Google Maps, and having an individual social presence. Whatever isn’t provided, you will need to take care of yourself.
A centralised marketing approach may extend to a common 0800/0508 call centre and email platform. This should all be spelled out in the franchise agreement.
Most franchise systems have a track record of success, with established franchisees who have achieved profitability and growth. This track record can provide prospective franchisees with confidence in the viability of the business opportunity and a network of experience to call upon if needed.
Your franchise system will probably offer a level of training and support. Training is generally provided upfront. The costs of training may be included in the franchise costs, or may be separate. These costs can be material if new franchisees buying an existing franchise outlet need to pay for training as part of the purchase of an existing franchise business. When you buy an independent small business, the vendor provides that initial training, generally as part of what you pay to buy the business. This is not always the case when buying an existing franchise.
Ongoing training and support are typically provided (when necessary) as a part of the franchise system costs. Increasingly, training is being offered online (e.g., on-demand video courses), or combined with annual franchisee conferences. Make sure you understand how you can gain new skills needed in your business, and what the costs of this ongoing training and support will be.
I have seen two extremes in the level of support franchisees receive from their franchisor. Some franchisors take the approach that they will do everything they can to (a) ensure you will be successful, or (b) at least you will not fail. At the other extreme are franchisors that bank your franchise fee and pretty much leave you to it. Make sure you talk to a few existing franchisees to see the level of support the franchisor provides.
Overlaid on this is the network of other franchisees in your geography, and the degree to which franchisees are inclined or incented to help their fellow franchise owners. Again, this is something you should look into before buying into the franchise system. For example, where do the new innovations come from? Other franchisees, or through the franchisor? A great franchise benefit for new business owners can be continuous product development and system innovation. Running a business as well as trying to successfully develop new offerings for customers can be overwhelming. Leaving this to your franchise system is a better way to go, at least while you learn the ropes.
In many franchise systems, franchisees enjoy economies of scale, typically through group buying of supplies, equipment, and services. Most franchise outlets are small businesses without much buying leverage, so group buying power will lower costs and provide a more secure supply chain. Of course, these group buying facilities can also be a constraint on your choice of suppliers. You may have access to better pricing than the franchisor due to a pre-existing relationship, for instance, but be precluded from those cost benefits by the franchise system procurement rules.
Most franchise systems limit the level of internal competition. This is generally done by assigning exclusive territories. Make sure you understand how this works in your franchise system. An exclusive territory can mean no other franchisee can provide services into your territory, or may only mean incoming referrals to the franchisor are assigned based on the franchisee territories. In the latter case, another franchisee may still be able to work in your territory where they have generated the lead themselves.
Another territory model is for the franchise system to include rules on the location of outlets (generally only in the case of physical stores). The franchise rules might require that no other franchisee can open an outlet within 5km of an existing store, for example, even if an exclusive territory is adjacent to other franchisees.
Before You Commit
If you are attracted to the idea of being part of a franchise system, it will pay to take a look at different systems, even across different industries. Do your due diligence on the franchise system, franchisor, and the existing franchise network. Meet with the master franchisor to understand what they require of you, and how they can assist you develop your business.
Your evaluation should consider the following types of issues (in addition to those notes in the previous section).
Assess the reputation of the franchisor, the franchise system, and the franchise brand. You are attaching your name to that reputation. Make sure it will be positive for your business. Look at the likely customer base, and ask people who could be customers what their impression is. You only want to invest in a successful franchise system, one that will help you achieve your goals.
What are your upfront and ongoing costs? Posing this question will help you understand how the franchisor makes their money from your business. You will find quite a wide array of costs and methods across the different systems. For a greenfield territory, there will be some type of initial franchisee fee to secure that territory. This fee may or may not include the equipment and inventory you’ll need to establish the business. In addition, there may be an additional training fee at startup. After that, there may be ongoing royalty and marketing fees (typically monthly) that will be charged as a flat fee or as a percentage of revenue. Most franchisors will be able to provide a sample budget for the startup and first year or so. It is really important to have a clear understanding of how much you will need to commit to the business, and what your investment return is likely to be. Also try asking for the financials of other (existing) businesses in the franchise that have a similar catchment area to see what others have achieved.
If you are buying an existing franchise business, the vendor needs to provide you with comprehensive financials for the prior 3 to 5 years. Most of your due diligence will be the same as you would do for an independent business.
Carefully review the franchise agreement. It is a good idea to get a lawyer familiar with these types of agreements involved in the review. Make sure you understand any franchise term limits or performance requirements that you need to meet. Almost all franchise systems have an initial term and some performance requirements. Remember: you are the franchisor’s customer. You generate their revenue. If you underperform, the franchisor is missing potential revenue. To protect the franchisor from underperforming franchisees, there is likely a termination (or buyback) clause.
Plot the territory you are buying, and include the adjacent territories to understand the limits of your space. Be careful to understand how the territory system works for the franchise system.
Drill down on the level of support the franchisor and overall system provide.
More broadly, understand the level of flexibility and autonomy you will have in the agreement. Compare this against how much you would like to have. Will you be OK with how things are done, or will you be constantly butting heads with the franchisor? Note that the amount of freedom you are likely to want will change over time. As you gain more experience, you will see new opportunities.
An area that commonly causes conflict between franchisee and franchisor is the level of time commitment the franchisee is expected to put into the business. For the first couple of years (at least), the franchisor will want you to be full time in the business. A franchise is not a side gig, and you are the person the franchisor has vetted as being suitable to run the business. You typically don’t get to sit back and have others run the business for you.
This highlights an aspect many potential buyers couldn’t understand: what are your preferences as a business owner? If you have never owned your own business, this can be very hard to answer. But I assure you, it will be something you will learn quite quickly.
Ensure the information you are reviewing is current and for the franchise in your area. Reviewing the generic agreement on the corporate website may lack essential detail that has a material impact on your return on investment and level of risk.
Understand the market demand and level of competition in your area (beyond just your territory). Who are your competitors likely to be? Your franchisor is likely to see the competition differently. As you are the franchisor’s customer, other franchise systems are their primary competition.
As the saying goes, start with your exit in mind. Before you finalise the buy-in, understand how you plan to exit. What are the rules the franchise system has around selling the business, transferring ownership to someone else, or (at an extreme) closing the business down? Is there a buyback provision (where you can only sell the business back to the franchisor based on a predetermined valuation formula)? How can the franchisor otherwise limit the sale of your business or negatively impact the price you will get when you exit? In most cases, an incoming franchisee needs to be approved by the franchisor before the deal is finalised. There may be costs to train the new franchisee. Who pays those fees? Can you transfer the franchise to a family member without this vetting? Your advisors should be able to steer you through these issues.
Another exit consideration is whether there is a restraint of trade after you leave the franchise. This is a common restriction in franchise agreements. And because this restraint isn’t related to an employment agreement with the franchisor, any contractual limits agreed to are likely to be fully enforceable in the courts.
Some franchise businesses will require you to comply with licensing and regulatory requirements. Make sure you understand these requirements and ensure you can meet them.
Finally, ask the franchisor for their stats on franchisee success. Good franchise systems will have something like a Franchise Disclosure Document. This is a document the franchisor prepares for prospective franchisees, outlining the key requirements of the franchise system and key stats like how many franchisees have been terminated or failed (shut down) in the last 5 or so years, information about the master franchisor, the costs involved in being a franchisee, rules around renewal and termination, training requirements, and ongoing franchise support. Members of the Franchise Association of New Zealand (FANZ) encourage their members to have this type of information available.
Ask to speak to existing franchisees to get a good sense of their experience with the franchisor. Are they helpful and responsive? Are they financially stable? Has there been any litigation between the franchisor and a franchisee? The other franchisees will have all the scuttlebutt.
Moving Ahead
If you want to buy into a franchise system, you generally have two options: (a) buy an existing franchise business, or (b) establish a new ‘greenfield’ franchise territory. In most cases, buying an existing franchise business is much lower risk for the buyer. The buyer can take comfort from the trading history of the existing business, which generally demonstrates the likely or ‘normal’ revenues and earnings. While there are no guarantees this level of income will continue under new ownership, this applies to any business purchase.
Taking on a greenfield franchise territory is very different. You need to establish the business in that territory without any certainty of customer interest. Again, while this may appear no different from starting any new business, there are some critical differences. In most franchise systems, you have a fixed territory, which constrains where you can base your business. You have higher start-up costs to comply with the franchise agreement without any degree of success. The franchisor may even require you to get their approval for any site you select, and for the fitout. The franchise agreement will often limit what business activities you undertake: if you see a local opportunity to tack onto your business, you often will not be able to extend into this space as it dilutes the standardisation the franchisor is trying to achieve across their brand.
Despite the highlighted drawbacks, owning and running a franchise business can be a great choice for people who haven’t run a business before, or are moving into a new geography or industry. You are buying into a complete system that (in most cases) has been tested and works successfully. I often describe franchises as being an ideal training ground for new operators – an MBA in running a small business.
For Your Consideration
All in all, franchising is a great opportunity for aspiring business owners seeking the benefits of self-employment with the support of a proven business model and network. But not all franchises are made the same way. Do your due diligence. Focus on the one that best fits you and your goals. Take advantage of the franchise system’s established brand, economies of scale, and training and support to accelerate your launch into business ownership.
It is also crucial to recognise that franchising has its challenges. Many of these, like startup costs, are the same you will find in any business. The additional challenges you should consider are the potential constraints imposed on you in the franchise agreement, your exit plan, and the level of support you get from the network.
If you’re considering buying into a franchise system, make sure you get effective and relevant advice. Get a coach before you start your journey to work with you through the assessment and due diligence phases. Discuss the opportunity with family and close friends, as well as getting input from your lawyer and accountant. There is a lot to consider. Will you buy a greenfield territory or an existing business? How will you fund the business startup or acquisition? How are you trained? Does the franchise system match your abilities and interests? Engage with existing franchisees to gain insights into their experiences with the franchisor and the system.
Finally, remember that franchise ownership can serve as an invaluable learning experience and a springboard to bigger and better things in the future, if that’s what you want.