Franchising

A Franchisor must get forecasting right

 

A Franchisor must get forecasting right

Since the early 1970’s buying and operating a franchise has been an increasingly popular way for many individuals to own and operate their own business.

 

Franchising Code of Conduct

Under Australian Law all Franchisors and Franchisees are now required to comply with the Franchising Code of Conduct (“FCC”). The FCC applies to all conduct that occurs on or after 1 January 2015 in respect of all franchise agreements that were entered into, transferred or renewed after 1 October 1998.

While it is possible that some older franchise operations may still fall outside these guidelines, given that the majority of franchise agreements are for a period of 5 – 10 years (possibly with an option for extension) a significant number of franchises currently operating in Australia today are likely to be caught by these provisions.

 

What is forecasting and why is it so important?

As franchising continues to increase in popularity, it is essential that both Franchisors and Franchisees understand their rights and obligations. In particular, the issue of accurate income forecasting is an area where costly disputes can easily arise.

Without accurate forecasting a potential Franchisee is unable to properly assess whether a particular franchise is likely to generate sufficient income to justify the purchase price. A failure to forecast accurately also puts a Franchisor at risk of a claim of misleading and deceptive conduct by a disgruntled Franchisee.

 

Disclosure Document

Prior to entering into a franchise agreement a Franchisor is required by the FCC to provide any prospective Franchisee with a Statement setting out the risks and potential benefits or rewards of being involved in a franchise together with a Disclosure Document (“Disclosure”) and the final form of the Franchise Agreement and a copy of the FCC.

The Disclosure must be provided at least 14 days prior to entering into any franchise agreement or the making any non-refundable payment to the Franchisor.

 

Future estimates must be based on reasonable grounds

The Disclosure is not required to contain an earnings forecast. However, if a forecast is included it is essential that the Franchisor highlights that earnings may vary between franchise locations and that the forecast does not estimate the potential earnings for any particular future Franchisee.

 

How is the earnings forecast calculated?

A Franchisor is within their rights not to disclose specific franchisee earnings or any earnings information at all. However, if these details are provided it is important to establish that a “like for like” situation is being forecasted.

Variables such as the location of the new franchise, the demographics of the area covered by the franchise agreement, estimated turnover, lead time for generating income, training requirements and a range of other factors may all affect whether an earnings estimate is likely to be accurate.

 

Reasonable grounds for making the forecast

It is a requirement of the FCC that if a Franchisor opts to provide any earnings information any information provided must be based on reasonable grounds. In addition, where an earnings forecast is included in the Disclosure then the Franchisor must advise:

  • Any facts or assumptions on which the forecast is based;
  • Details of the research undertaken and the extent of any enquiries made to support the forecast;
  • Whether the forecast includes any costs or write offs such as depreciation of assets, salary or wages for the franchisee, the cost of meeting any loans on the business (for example interest and repayments); and
  • Any assumptions built into the estimate regarding tax obligations.

It is critical that a Franchisor takes steps to ensure that they do not provide an estimate without reasonable grounds. If a Franchisor makes a forecast without reasonable grounds for making it then the forecast will be found to be misleading and is likely to contravene the Australian Consumer Law (“ACL”).

A Franchisor will be taken not to have had reasonable grounds for making the forecast unless they are able to show evidence to the contrary. While ACL does not go so far as to require a Franchisor to prove they had reasonable grounds a Franchisor will need to produce at least some evidence to support their claim that they had reasonable grounds for making the forecast.

Any individuals working for the Franchisor may also be held personally liable if they were involved in contravening the ACL.

 

What does it mean if a forecast turns out to be inaccurate?

Even when a Franchisor makes a forecast reasonably and with honest intentions it is possible that the forecast may later be found to be inaccurate. If this situation arises a Court will not look at the forecast with the benefit of hindsight but will instead take into account whether the Franchisor had reasonable grounds, at the time the forecast was made, and given the information available at the relevant time, for making the particular estimate or forecast.

Any Franchisor who knowingly or recklessly makes a false or inaccurate forecast without any regard for the likely accuracy of the forecast or where they are in possession of information which is contrary to the predicted outcome is likely to be found to have engaged in false and misleading conduct.

 

Tips for making forecasts

While every forecasting exercise will be different there are some general guidelines which are helpful when making an estimate or earnings forecast. These include:

  • Forecast conservatively – It is always better to estimate low in respect of earnings and overestimate potential expenses. It is highly unlikely a Franchisee will be upset if they end up making more money than the earnings forecast predicted;
  • Avoid assumptions, anecdotal evidence and hearsay – Cold hard facts and numbers are likely to be much more accurate than what you hear ‘on the grapevine’. Undertake appropriate research and include, as far as possible, accurate figures fixed and variable costs such as rent, operating costs and likely salaries. Take into account price differentials between different locations as earnings forecasts are unlikely to be a ‘one size fits all’ situation;
  • Keep copies of all documents – Properly document how you came to reach the forecast conclusions and keep copies of all documents on which the estimate is based;
  • Always go with “worst case” for earnings rather than “best case” hopes;
  • Never provide verbal forecasts or commentary – Verbal forecasts and commentary are a recipe for disaster and you may quickly find yourself embroiled in a “I said/they said” scenario;
  • Be wary of future representations – Do not promise to do things in the future unless you truly and honestly intend to act in the way you are promising and importantly, unless you honestly believe you have the capacity to do so;
  • Independently review forecasts prior to giving to a Franchisee – If possible have a third party review the estimates as a safety check; and
  • Prepare your forecast defensively – Consider how you would defend any forecast in Court if it was challenged and how you would meet the requirements of a substantiation notice requiring production within 21 days of any information or documents to substantiate a forecast if such a notice was issued by the ACCC.

 

Additional precautions

It is essential that a Franchisor take proactive steps to ensure that any forecast is based on reasonable grounds. We recommend that you consider obtaining legal advice from a suitably qualified and experienced lawyer prior to entering into providing any forecast. Your lawyer will also be able to advise you as to whether you should also seek additional advice from an accountant or business adviser.

If you or someone you know wants more information or needs help or advice, please contact us on 1300 149 140 or email ch@lawbase.com.au.