Articles by Jason Gehrke

As a rule of thumb, I recommend that a first-time potential franchisee be prepared to spend at least one hour of research for each thousand dollars they are looking to invest in a business.  Franchising continues to appeal to existing Australians who are looking to become self-employed, as well as new arrivals who qualify for business migration visas as a method of obtaining entry into Australia. However to buy and operate a successful franchise requires more than just having the cash to pay for it. Potential franchisees must be prepared to do some hard work to research and understand the business, the franchisor, and themselves in order to make the best possible decision. And here is the first hurdle: A potential franchisee must be prepared to roll up their sleeves and put some real time and effort (as well as some money via personal development and professional advice) into their franchise search. If not, they greatly increase their chances of picking the wrong franchise, and losing part or all of their investment. To increase the chances of picking the right franchise, here are some key pointers: What should I look out for? This boils down to three key things: Profitability. Sustainability and strong, competent Leadership. In good times, tough times, or anytime, these three criteria remain the same. Of course it’s rare that a franchisor will make representations about profitability or concede that their business is anything less than sustainable. It is rarer still that a franchisor would claim to have anything less than strong, competent leadership, so these concepts all need to be tested by a potential franchisee’s own research. If a potential franchise buyer is not prepared to invest the time to properly research what they are buying, then they must accept some or all of the responsibility if the investment fails. How much time should I spend researching a franchise? As a rule of thumb, I recommend that a first-time potential franchisee be prepared to spend at least one hour of research for each thousand dollars they are looking to invest in a business. For example, if a franchise costs $250,000, this amounts to up to 250 hours of research. That might sound like a lot, but the saying that a fool and his money is easily parted might have been created specifically for those people who recklessly invest after making hasty, ill-considered decisions. Most franchises offered at $250,000 and above will be retail businesses, so prior knowledge and experience in retailing may be useful and should be included as part of any pre-purchase research. What sort of research should I do? Such research might include (but not be limited to): Start your search for a franchise by visiting one of the upcoming franchise expos held each year in Australia Sydney, Brisbane, Melbourne and Perth, as well as look at  franchise opportunities online; Once you have shortlisted one or more franchise systems, carefully read through the information provided by the franchisor. You should also engage an experienced franchising lawyer and accountant, and read the documents for yourself as well as get professional advice. (Many franchisees fail to read their franchise contracts, and then afterwards discover they have signed for something that they didn’t know about or wouldn’t otherwise agree with. Reading the documentation for themselves will also help potential franchisees understand the advice they are being given, and to ask more informed questions of their advisors and the franchisor.) You should contact current franchisees in the system (or at least as many as possible) to ask them about their satisfaction with the franchise, the lessons they’ve learned along the way, and the sort of research they did (or wished they had done) before buying the franchise. The list of current franchisees and their contact details will be included in the franchisor’s disclosure document, however this document may only be available at a relatively advanced stage of negotiations with the franchisor, and in the meantime, franchisees’ details or locations may also be available on the franchisor’s website and in the telephone directory. You should also contact the former franchisees who have left the system in the last three years. Franchisors must provide a list of these franchisees and their contact details (where known) in the disclosure document. By contacting former franchisees, you will have an understanding of their satisfaction with the business and their reasons for exiting. Again it is important to contact as many as possible of the names provided. Calling just one or two is likely to provide a distorted positive or negative view of the system, and only after contacting the full list can a potential franchisee develop a balanced view of the satisfaction of former franchisees and why they left. Compare concepts. There is usually more than one franchise concept servicing a market niche (however unique], so check out the value of the competing offer. Even if the initial investment price is the same, similar franchises may have radically different fee structures, marketing levies, support systems, purchasing or other arrangements that can radically affect the long-term value and profitability of the business, or satisfaction of the franchisee. Verify for yourself any statements or representations made by the franchisor, or issues raised when contacting current and former franchisees. This might include even spending time doing market research such as counting houses in a territory, searching Australian Bureau of Statistics and other sources of data, counting vehicle or pedestrian traffic and directionality outside a potential shopfront, or many other things. While this may sound tedious, it’s all part of ensuring that the facts being used to make the decision to buy the business are the right facts; Consider if you should work part or full time for a period in a franchised store or territory to get a genuine feel for the business (in which case, the longer the better, and the one hour per $1,000 invested rule can be extended). People who have worked in franchises before buying them increase their operational proficiency and become culturally acclimatised to the organisation, thus reducing the likelihood of a horrible “I wished I’d known this before” moment after the investment has been made. Undertake small business and franchise training courses and workshops. People going into self-employment forthe first time don’t know what they don’t know and look to the franchisor to fill this void for them. This creates the opportunity for unscrupulous franchisors to abuse their trust, or for the franchisee to develop unrealistically high expectations of the system for which the franchisor cannot deliver.  Understanding basic principles of franchising, as well as basic business concepts and financial literacy are essential to improving and maximising the long-term value of any franchise investment. (The Franchise Advisory Centre (www.franchiseadvice.com.au) hold a number of workshops, seminars and short courses, as well as various state and federal bodies, and business/industry associations. What are the best franchises in the current economic climate? Established systems with a critical mass of profitable, satisfied franchisees will not only weather the current economic storm, they will come out the other side in top gear and quite possibly buy out or take market share from a competitor or two along the way. Furthermore, these systems will need to have dynamic and talented leadership teams, strong corporate governance, and enduring customer appeal. Having said that, concepts such as “established”, “critical mass”, “satisfied”, “dynamic”, “talented”, “corporate governance”, and “enduring appeal” are subjectively assessed, and relative to the eye of the beholder. An evaluation of a system on these criteria might produce different outcomes for different people. Cash businesses (or those with tight credit controls) combined with clever marketing and exceptional levels of customer service (and there are many examples of these in both service and retail franchise brands) that fit the above criteria will perform strongly in the next couple of years. What about new franchises? There is opportunity in adversity for any entrepreneur. New franchise concepts emerge in Australia at the rate of about 100 per year, however not all of these will be viable in the long run. There may be more risk associated with investing in a new franchise system with just a handful of franchisees, compared to larger and more-established brands, however there may also be more flexibility and growth opportunities for franchisees of new systems.  It is also possible that the franchisor’s training, field support and marketing assistance for new franchisees may not be as well-developed in new systems compared to established systems. What should I be wary of? The recently-unemployed, particularly those with sizeable payouts for years of accumulated service, holiday pay, etc, are prey for unscrupulous operators. In particular, advertisements that claim a business is a “license, not a franchise”, or which include income guarantees or similar offers should be approached with caution. It is essential that business migrants, some of whom will not have been in business for themselves before, may well make excellent franchisees. However their potential naïveté makes them particularly vulnerable to poorly-considered decisions, hastened by unnecessarily eager franchise salesmen. Migrant franchisees should also be wary of offers to buy multiple outlets at the same time, or master franchises. It will be difficult enough in most cases to learn how to operate just one business, without compounding the challenge across many businesses. The key lesson here is to undertake proper research. (See research hints above). What laws exist to protect franchisees? It is also worth noting that although the last recession occurred before the Franchising Code of Conduct was introduced (ie. the laws that regulate the franchise sector], there is no amount of legislation that can adequately protect a franchisee from a hasty, unresearched and ill-considered investment decision. Distributorships and licensed business opportunities are often advertised alongside franchises, but look, sound and feel the same as a franchise. No matter what they call themselves, if they meet the four criteria in the Franchising Code, then they are a franchise. This entitles potential franchisees to receive a disclosure document (containing a variety of important information as well as the lists of current and former franchisees critical for proper research], as well as a mandatory cooling-off period, recourse to mediation in the event of a dispute and all the other protections available to franchisees under the Franchising Code of Conduct. The best way to distinguish between a legitimate franchise offering and something that is designed to separate an aspiring business owner from their cash is to educate yourself, and do your research. Only then can you make a balanced decision that takes into account your long-term interests. Where do I go for help? Visit the Franchise Council of Australia’s website at www.franchise.org.au to see if the franchise that interests you is a member. Membership of the Franchise Council means that franchisors have agreed to an even higher standard of conduct than the minimum required under the Franchising Code of Conduct. Also visit the Franchise Advisory Centre website at www.franchiseadvice.com.au for many free articles on what you should know before buying a franchise. Jason Gehrke is a director of the Franchise Advisory Centre and has been involved in franchising for 30 years at franchisee, franchisor and advisor level. He provides consulting services to both franchisors and franchisees, and conducts franchise education programs throughout Australia. He has been awarded for his franchise achievements, and publishes Franchise News & Events, Australia’s only fortnightly electronic news bulletin on franchising issues. www.franchiseadvice.com.au 

Although bank interest rates are at record lows in Australia, many potential franchisees still can’t raise the finance to acquire a franchise and are increasingly turning to non-bank lenders, particularly their parents and family members. The Franchise Advisory Centre estimates around 10% of new franchisees are now funded or underwritten by family finance, which it terms the Bank of Mum and Dad (BOMAD). BOMAD financing is very different from traditional bank lending. Banks will methodically and unemotionally evaluate a loan application, and will ultimately price their risk based on the security offered by the borrower, and their capacity to service the loan. The security requirement will normally boil down to bricks-and-mortar real estate (usually the borrower’s home], and the servicing requirement will be assessed on the business’ capacity to generate enough cash to repay the loan and meet all its other obligations (as well as pay a reasonable rate of return to the operator). BOMAD financing on the other hand, is often based on emotional, rather than purely financial considerations. If the Bank of Mum and Dad underwrites a loan provided by a bank by giving personal guarantees, or putting their house up for security, they bear secondary risk if the franchise goes bad and the loan is not repaid. However, if the Bank of Mum and Dad is the loan provider themselves, they bear the primary risk if the loan goes bad, which can have a flow-on effect to the relationship between the family members involved. There are a number of advantages and disadvantages of BOMAD financing for franchisors and franchisees. Here are a few: Advantages for franchisors: Access to younger, potentially more talented candidates With Baby Boomers approaching retirement age, more and more franchisees are coming from the ranks of Generation X and Generation Y. Generation X are often mortgaged to the hilt due to the rising property market, so have some real estate equity for security, but often not enough to buy a business. On the other hand, Generation Y can’t afford to enter the property market, so rarely have any real estate equity to offer. However both of these generations bring youth and vigour to franchising and are desirable candidates for franchisors. BOMAD financing may be the only way they can afford to get into business for themselves. Disadvantages for franchisors: The loan is not treated as seriously as bank finance A franchisee risks all manner of adverse consequences if they miss repayments or default on a bank loan. These consequences are often absent for a BOMAD loan, which may not even be documented with a loan agreement between the parties. Therefore if the cost of failure to a franchisee is low, their drive to succeed may also be low. This is not a strong recipe for success and if the franchisee loses money, they may simply treat it as an advance on their inheritance, which might upset the family dynamics for a bit, but is often nowhere near as severe as what will happen if a bank doesn’t get repaid. Mum and Dad might end up running the business If the business underperforms badly, the franchisee’s parents may become so concerned about their investment that they step in to influence the operation of the business, or are forced to take control altogether. This form of reverse inheritance (ie. the kids passing something to their parents) is a nightmare for franchisors, and even though it might be a breach of the franchise agreement, may be tolerated in preference to shutting down the outlet altogether. The parents who end up running the business might never have attended franchise training, or fully understand the operations and culture of the business. Often for the franchisor, this makes a bad situation worse. Advantages for franchisees: Potentially easier access to finance on more favourable terms Borrowing from the Bank of Mum and Dad may not require any securitisation, and may involve other more favourable terms (such as a lower rate of interest) compared to a bank loan. This can make life a lot easier for the franchisee, so long as they treat the loan seriously, which means at the very least they should still prepare a business plan and agree to minimum repayments over a set timeframe just the same as they would need to for a bank. Plus, Mum and Dad as proud (and invested parents) will always be more supportive and interested in the franchisee’s success than a bank. Disadvantages for franchisees: Interfering parents Just as Mum and Dad are proud of their child’s achievements in business (with their money], so too will they offer unsolicited advice, guidance and other assistance that may be counter to the franchisee’s training or intuition, and be far less helpful than intended. Often this unsolicited support will be an unhelpful distraction to the smooth operation of the business, and at other times, it will be extremely useful. The key for the franchisee is to take the rough with the smooth, filter appropriately, and understand that all help offered by parents is generally made with the best of intentions. Lack of proper documentation BOMAD loans are often undocumented, meaning they are not written down but are loosely based on a handshake or mutual understanding. If they are written down anywhere, they are rarely anywhere near the standard required for a bank loan. To eliminate the opportunity for future family arguments over money, BOMAD loans need to be documented via a formal loan agreement between the borrower and lender, indicating the principal to be lent, the term of the loan, the rate of interest to apply, and the consequences of default. Additionally, the parents should amend their wills to acknowledge the loan as an asset of their estate, and outline whether the loan should be offset against any other inheritance due to the child in the event of their passing.  This helps reduce the potential for ugly disputes between siblings when dealing with their parents’ estate, or the risk of an executor calling-in the loan to settle the affairs of the estate. A franchisor would be wise to ensure that any BOMAD-financed franchisee has a proper loan agreement. It may even make it a condition of granting the franchise that it be provided with a copy of the loan agreement to ensure that the franchisee is committed to repaying the loan and that the conditions of the loan are consistent with those of the franchise. The bottom line This is not an exhaustive list of the pros and cons of BOMAD financing, however it does highlight some key considerations for both franchisees and franchisors. BOMAD financing is expected to grow in future and those franchisors who learn how to embrace it whilst managing its associated risks wiill potentially accelerate their growth compared to those who don’t. Jason Gehrke is the director of the Franchise Advisory Centre and has been involved in franchising for more than 25 years at franchisee, franchisor and advisor level.

After more than 25 years in franchising, I’ve seen both franchisees and franchisors achieve spectacular success, and others lose it all. There is no such thing as a sure bet in business, but franchising helps reduce the risks of small business by providing a supported environment utilising both the resources of the franchisor, and the community of franchisees operating under the same brand. Franchisees do not invest in businesses to lose money, but by the same token they don’t always do enough to mitigate their risks either. If their business fails, the franchisor is the obvious target for the franchisee to blame, and on occasion, this is justified. However, franchisees are often the architects of their own misfortune for a variety of reasons that they can’t or won’t acknowledge in time to save the business. So between franchisor-related reasons and franchisee-related reasons, here’s my top 10 list of causes of franchisee failure (and which can occur in any order, depending on the business): Franchisor causes: 1. Bad business model The franchisor’s business model might be the first thing that franchisees would like to blame for their failure, but this is not always the case. Underdeveloped business models are likely to be found in new, start-up networks, and this should be factored into a potential franchisee’s assessment of the risks of joining. While the business model risk may be greatest for a new franchisor, it can also re-emerge as a potential cause of failure in mature networks unable to match the pace of change set by nimble competitors, or which have otherwise failed to evolve with their market. 2. Inadequate training & support Failure caused by poor training or subsequent levels of support is also likely to occur in newer, start-up systems compared to mature brands. Training and support is typically limited to operational matters in new brands, with little or no general business training provided. Franchisees can better protect themselves from training and support problems by better understanding in advance the nature, content, frequency and assessment of training and support provided by the franchisor, and if it doesn’t seem adequate, to either ask for more or look for another system altogether. 3. Insolvency When franchisors go broke, often their franchisees will be unable to survive because functions such as marketing, supply chain logistics, IT and other core activities that hold the network together may be wound back or cease altogether. Again, the greatest risk of franchisor failure is among newer, start-up franchisors, but even mature brands on occasion can fail, such as Angus & Robertson in 2011, and Kleins and Kleeinmaid in 2008. Franchisee causes: 4. Wrong fit A potential franchisee may love a business from a customer’s point of view, and from this, decide that the business is one that they would like to run (because they love the products or services so much). Unfortunately there is a big difference between loving the products or services, and loving the challenge of running a business that sells those products or services. Sometimess franchisees, no matter how passionate they are about the product, the brand or the industry, just are not suited to the business. They may not be dynamic enough to evolve with the business over time, incapable of managing or retaining staff, or a whole bunch of other reasons that is best summarised by simply being the wrong fit for the business. 5. Insufficient planning A failure to plan is a plan to fail. Despite the obvious wisdom of this saying, many franchisees still fail to prepare a business plan before commencing their franchise (and on the flipside, many franchisors fail to insist on one either). A business plan should be a road map that shows the way to achieve profits by certain milestones. The franchisor should be involved in the planning process and should analyse and constantly monitor business plans submited by franchisees to ensure that the franchisee operates their business acording to the plan. 6. Insufficient working capital & reinvestment A lack of working capital and a lack of reinvestment are among the most common causes of all business failure (not just franchising). Franchisees who start operating businesses without adequate working capital will be unable to pay their bills when they fall due if the amount of cash coming into the business is not greater than the amount of cash going out. Even if the business is profitable, it can still fail if its customers have not paid it on time and it runs out of money to pay its own bills when they fall due. Understanding the difference between cash flow and profit can mean the difference between surviving and failing. Likewise with reinvesting in the business – a failure to do so progressively could eventually result in massive reinvestment works that can send a franchisee broke. 7. Unrealistic expectations The best way to test whether or not a franchisee has unrealistic expectations about the future of their business is to examine their business plan. This will provide an essential insight into their financial expectations (and when they expect to achieve them], but there may be other unrealistic expectations based around training, support and the flexibility of the business model, among other things. The problem with assessing expectations in advance is that they are rarely articulated to the franchisor until after the expectations have failed to have been met. 8. Other distractions (stealing from themselves) Sometimes the cause of a franchisee’s business failure is not related to the franchise at all, but something else altogether. If a franchisee is comfortable with the performance of their business, they may look elsewhere for a challenge and find another business or interest to keep them occupied. Often this will take too much of the franchisee’s time (and their money) away from the franchised business to suit the new venture. Where this occurs, franchisees effectively steal from themselves by taking valuable capital and human resources from one business to support another. When the left hand robs the right hand, both hands risk losing the lot. 9. Failure to evolve (complacency) The market in which the franchisee’s business operates is constantly changing, and if the franchisee doesn’t change with that market, they will ultimately become irrelevent.  Fortunately for the franchisee, they are not alone on this journey of constant change, as the franchisor must also evolve to keep up with the market as well. However if the franchisee is too complacent with their business (or has their attention elsewhere) to adapt to change, their business will inevitably suffer. 10. Failure to follow the system Despite investing in a franchise with a prescribed way of doing things, some franchisees think they can do it better and instead of following the franchise system, they buck the system and try to do their own thing. Franchisors are the first to admit that franchisees can come up with excellent ideas to improve a whole system, but if some of their ideas are completely at odds with the brand offer and values then the franchisee may as well have bought an independent small business instead. Not only do franchisees who fail to follow the system risk censure and even termination by their franchisor, but they often sabotage their own business in doing so, causing sales and profits to decline. This is not an exhaustive list of reasons why franchisees fail. Nor are these reasons independent of each other, and sometimes two or more are responsible for a franchisee’s business to collapse. So now that you’ve read the top 10 reasons for a franchisee’s business to fail, what are you going to do differently to make sure that none of these happen to you? Jason Gehrke is a director of the Franchise Advisory Centre and has been involved in franchising for 25 years at franchisee, franchisor and advisor level. He provides consulting services to both franchisors and franchisees, and conducts franchise education programs throughout Australia. He has been awarded for his franchise achievements, and publishes Franchise News & Events, Australia’s only fortnightly electronic news bulletin on franchising issues. In his spare time, Jason is a passionate collector of military antiques.

The words “buy” and “sell” are often used in relation to the acquisition and transfer of franchise businesses, but what do franchisees actually buy? The overwhelming majority of people who are attracted to franchising are first timers in business who are drawn by the branding, support and infrastructure provided by a franchise chain that takes the pain out of reinventing the business wheel. Without prior experience in business, potential franchisees have no comparable frames of reference in their decision making process, and consequently often revert to the same types of processes used in other major acquisitions, such as the purchase of a car or a house. In buying either a car or a house, the purchaser is required to still undertake their due diligence to protect their interests, and for houses (and most cars) will also need to sign a contract. Of course the nature of the due diligence between the purchase of cars and homes compared to that required for the acquisition of a business is very different, although many of the same principles apply. One of the commonalities is the emotional investment in the decision being made. People buy the cars they drive and houses in which they live based on a number of factors, all of which can be summarized as simply a liking for the car or the house. This emotionally-led decision (along with the elimination of options the buyer didn’t like) then becomes the frame of reference by which they also seek franchises (ie. they seek to acquire one they like], without appreciating that liking something may not be enough to actually make any money out of it. A key difference between the transaction to acquire a car or house and a franchise is the outcome itself, which many potential franchisees don’t fully understand up front. The outcome referred to here is ownership. When a buyer puts their money down to buy a car or a house (or a fridge, TV or anything else], the item becomes theirs. This ownership of the item (even if it is mortgaged to a financier) allows the buyer great freedom to do pretty much what they please with the item. If they don’t like the colour of the house, they can repaint it. If it’s too small, they can extend it. If it’s too old, they can renovate it, and so on. Likewise with buying a car. The new owner can drive the car fast or slow, on bitumen or on dirt, with roof racks or without, and can accessorise the vehicle to their heart’s content with window tinting, tow bars, entertainment systems, mag wheels and so on. Cars and houses are usually bought under finance, and where conditions are applied to the ownership of the item, it is usually dependent on the loan being repaid and kept up to date. Buying accessories for the car or furniture for the house involves the same process of making a desired selection, paying for it, then choosing what happens with these items thereafter. The point is that by paying their money, the buyer can do more or less what they please with the item they’ve bought. Ownership provides the freedom to determine the future look, feel, fashion, usage, functionality and worth of the item bought, and generally this freedom to choose is determined almost entirely on the person’s ability to pay for the item and whatever they wish to do with it afterwards. Which brings us to the acquisition of a franchise, which, on the face of it involves a similar process of “buying” something, however the outcome is totally different. A “buyer” will go through a similar process of finding something that appeals to them in (or slightly above) a price range they can afford, as if they are buying a car or a house. But while having the money alone may be enough to qualify a person to buy a car or a house, it is just one consideration in the process of acquiring a franchise, which is why franchises aren’t bought. A franchise is defined as a conditional grant, which is very different from outright ownership. The conditions attached to a franchise grant are set by the franchisor in the best interests of the system and the brand, and which may change over time. Failing to observe the conditions of the grant at all times may result in the grant being withdrawn. So unlike the case of buying a house or a car where the vendor is paid their money and then has no further interest in the item sold, a franchisor is not only paid the money upfront (plus usually an ongoing fee], but also takes a very close interest in the ongoing welfare and performance of the franchise. Ultimately, the franchisor also has the power to withdraw the franchise if the franchisee fails to follow the system guidelines which they are required to uphold. Therefore buying a franchise is very different from buying anything else, yet precious few franchisees fully appreciate this in advance. By subconsciously equating the purchase of a franchise with the purchase of a car or a house, potential franchise buyers also assume that the ability to pay and a desire to acquire are enough for the purchase to proceed. Nothing could be further from the truth. Most franchise systems have rigorous selection criteria and seek specific attributes among potential franchisees that money and desire alone cannot overcome. Failing to understand this in advance can be both confusing and annoying for a potential franchisee who learns they do not have the necessary attributes to join the system on which they had set their sights. For this reason, potential franchisees need to be informed up front that there can be no guarantee that they will be successful in their quest for a franchise. Many systems can do better in this regard by changing some of the words used in the franchise application process. A simple first step is to refer to potential franchisees as candidates instead of buyers, leads, etc. The use of the word candidate conveys that there can be no guaranteed outcome in the selection process, irrespective of how much money the person may have or how keen they are to join the franchise. To be a successful candidate in other walks of life requires that a person have the qualities required to survive some kind of screening or elimination process. Unfortunately when the perception of buying a franchise is subconsciously compared with buying cars or houses, candidates at first acknowledge the ability to pay as the only qualification required to be granted a franchise. By referring to potential franchisees as candidates, and explaining the selection process up front, franchisors can more effectively identify both suitable and unsuitable candidates, as well as improve the quality of new entrants to the system, while at the same time demonstrating real value in the franchise grant on offer. In doing so, franchisors also reinforce the conditional nature of the franchise grant, making it clear to incoming franchisees that accessorizing their businesses like they would with a new car or a house will require the consent of the franchisor, and cannot be done on a whim alone. After all, every other franchisee in the network has made a similar investment, and protecting the value of those investments requires that all franchisees must adhere to standards in the operation of their businesses. For these reasons, “buying” a franchise is very different from buying a house, and should be approached by both franchisors and franchise candidates very differently. Jason Gehrke is a director of the Franchise Advisory Centre and has been involved in franchising for 20 years at franchisee, franchisor and advisor level. He provides consulting services to both franchisors and franchisees, and conducts franchise education programs throughout Australia. He has been awarded for his franchise achievements, and publishes Franchise News & Events, Australia’s only fortnightly electronic news bulletin on franchising issues.

At the point of receiving disclosure documentation, many potential franchisees are recommended by their franchisors to use the Franchising Code’s 14-daywaiting period to undertake their due diligence on the franchise investment. The problem for many potential franchisees at this point is that they don’t know what due diligence is and may have never heard the term before. They may figure due diligence must be something that is expensive and complicated and therefore done by the lawyers or other professional advisors that they might engage to handle \"the paperwork\" of the sale. In other words, it's something difficult done by somebody else. Nothing could be further from the truth. Due diligence is no more complicated than looking at the facts of a deal from all angles to make sure they stack up. In short, due diligence assesses the risks and opportunities of a proposed transaction, be it buying a business or entering some other arrangement. Conducting a building inspection and title search as a condition of buying a house is an example of due diligence in areal estate transaction. Getting engaged and taking the time to know someone before getting married is a form of due diligence (occasionally supplemented today by Googling a potential partner's details, or searching their Twitter and Facebook pages, etc). Most people who buy a second hand car insist on first taking it for a test-drive, conduct a title check, get a mechanic to look over the vehicle, and ask questions of other people who have owned the same type of car. This is considered natural behaviour when buying a car and forms part of our pre-purchase due diligence. By comparison, why wouldn't a potential franchisee or business buyer want to do the same thing when going into business for the first time? Unfortunately, many franchisors can recount examples of franchisees who have been too eager to join the system and then conducted little or no due diligence - with the result that their businesses failed to meet their expectations and both franchisor and franchisee become estranged. Here are some other definitions of due diligence to help potential franchisees understand the concept: The process of investigating a potential investment; The care a reasonable person should take before committing to a transaction; An assessment of the desirability, value and potential of an investment opportunity; Background research to determine the worthiness of an acquisition.  Who is responsible for undertaking due diligence? The potential buyer is responsible for undertaking due diligence. Although there is a statutory requirement for disclosure under the Franchising Code of Conduct, franchisors are not required to ensure that franchisees actually undertake due diligence. Even where a statutory disclosure obligation exists under the Code, buyers should - as much as possible - seek to independently verify information presented to them in order to reduce the risk of making a purchase decision based on false, out of date or incomplete information. Buyers will usually involve professional advisors to assist in the due diligence process. These will generally include accountants (to assess financial data and issues], lawyers (to assess legal, contractual and mandatory compliance issues) and specialists relevant to the industry or market sector in which the business operates. Irrespective of the use of advisors, the buyer takes ultimate responsibility for the decision to invest in the business offered. The buyer takes full responsibility both for the investment decision, and for the completeness of the due diligence process which gave rise to that investment decision. Buyer to act in own interest In any commercial transaction, the buyer has a choice to proceed or not proceed with the deal. It is expected that a seller will act in their own interest to maximise their benefit from the transaction, and by the same token, so should buyers. However, many people who buy small businesses or franchises have little or no prior experience in undertaking such deals. As a result, they may have little or no understanding of due diligence, and instead rely solely on their accountants and lawyers, and the veracity of the information provided by the franchisor. Unfortunately, without an adequate knowledge as to what a proper due diligence process should involve, the buyer is limited in their ability to protect their own interests. They may fail to seek professional advice in the first place, or fail to understand the advice provided. More importantly, they may simply fail to verify the information provided by the franchisor, and rely on untested detail. If the buyer does not act in their own interests, they cannot expect that their advisors alone will be able to do so, or that sellers will either. The cost of due diligence There are at least two types of cost involved in conducting due diligence: hard and soft costs. Hard costs are cash outlays, which can be substantial. It requires an investment of time and cash to research information and pay advisors. The Franchise Advisory Centre recommends that potential franchisees be prepared to pay at least between 2-5% of the cost of a franchise on due diligence alone. In other words, if the franchise costs$100,000, then the potential franchisee should be prepared to spend between $2,000 and $5,000 on their due diligence. If, after conducting a due diligence process a buyer decides not to proceed, then the cost of due diligence will be significantly less than the potential losses the buyer would have incurred if they had proceeded with the business and it subsequently failed. By far the greatest cost of any due diligence process is the cost of professional advisors (ie. accountants, lawyers and other professionals engaged for their expertise). These advisors will usually work on a per hour or project rate, and so it stands that the greater the investment, the more diligence required, the greater the advisor costs will be. It goes without saying that professional advisors acting for the buyer will require payment whether or not the buyer completes the sale. While this could mean that the buyer will ”lose\" the cost of the due diligence by not completing the sale, this might be a very small loss compared to the cost of buying an unsuitable or unsustainable business. Soft costs are the costs of the buyer’s time. Time spent researching a business is not something a buyer can expect to be paid for or have deducted from the purchase price of the business. The buyer invests their time and energy in considering the transaction, and should the transaction not be completed, the buyer at least is usually better-prepared and more experienced to undertake the next due diligence process. As a general rule, potential franchisees should make a due diligence soft cost investment of one hour of time per $1,000 to  be invested in the business. This can be spent on researching the specific business opportunity, as well as the industry and business in general and will ensure that a reasonable amount of time is allocated to assessing the risks and opportunities of the proposed transaction. Verify disclosure information Potential franchisees will rely primarily on information provided in the franchisor’s disclosure document, and should make every attempt to independently verify each item in the document to ensure that the information presented is current and correct. It is important to remember that disclosure documents under the Code are required to be updated within four months of the end of the financial year (which for most systems will be October 31 for the preceding12 month period July to June). Consequently, a franchisee who receives a disclosure document in July, August or September in any given year could be looking at information which is 12months or more old. If this is the case, the potential franchisee may choose to request a more recent disclosure document, or defer a purchase decision until after the disclosure document is updated. Jason Gehrke is a director of the Franchise Advisory Centre and has been involved in franchising for 18 years at franchisee, franchisor and advisor level. He provides consulting services to both franchisors and franchisees, and conducts franchise education programs throughout Australia. He has been awarded for his franchise achievements, and publishes Franchise News &Events, Australia’s only fortnightly electronic news bulletin on franchising issues