Setting up a Franchise Business

Setting up a franchise business involves a number of important choices that will affect the simplicity of operating the business, future taxation liabilities and the ease of exiting from the business at a future point in time. Similarly, there is a series of regulatory procedures that must be completed prior to the purchase of your franchise business. For new franchise business owners the degree of regulation and compliance obligations may come as a shock!

We regularly assist business owners in setting up their businesses. We also often come across new clients that were poorly advised when they set up their businesses, and often it is too late to unwind the decisions that were made when the business was established. Some of the key issues we recommend you consider on setting up a franchise business include:

• Choice of an appropriate business structure
• Franchise agreement review
• Business plan
• Taxation
• Financial forecasts and cash flow
• Registrations
• Lifestyle

In this article I will provide an explanation of some of these issues when setting up a franchise business.

Choice of an appropriate business structure

Typical business structures include operating as a sole trader, in partnership, a company and various types of trusts. Generally a company or a trust, or perhaps a combination of the two, is an appropriate structure for operating a franchise business. This is because both a company and a trust may offer some protection of business risk for the business owners from customers and suppliers. However, the two types of entities may vary significantly in respect of future taxation liabilities and the flexibility for distribution of income from the entities. Often a company is chosen by business owners because a company is relatively simple to establish and easy to understand. However, it is not unusual for us to find that our new clients with simple company structures result in business owners paying more tax than what may be paid under a more appropriate business structure, including the use of trusts. You should seek advice from a qualified accountant when choosing an appropriate business structure to meet your franchise needs.

Franchise agreement

The franchise agreement is the critical document that sets out your rights and obligations when operating your business. We strongly advise you seek legal advice when reviewing a franchise agreement early in your negotiations with the franchisor. Similarly, your franchise agreement will set out your future fee structure (such as ongoing franchise fees and marketing levies). The fee structure needs to be understood to prepare your financial forecasts.

Business plan

All franchise business owners planning to set up a franchise business should start by preparing a business plan. A business plan forces the business owner to apply some ‘discipline’ in documenting a strategy for the business. Some of the issues you may wish to document in your business plan include:

• your vision or mission statement
• a brief history of your business and business successes to date
• identification of key stakeholders and staff members and their roles in the business
• an analysis of your market (who are your customers, what makes them come back and what additional customers you could access)
• support, knowledge and training available from the franchisor
• a financial analysis, including a financial forecast and a list of assumptions on which your forecast is based
• a summary of your business strengths, weaknesses, opportunities and threats (a SWOT analysis)
• a list of organisational and operational issues for resolution, including, any weaknesses or threats in your SWOT analysis requiring attention, and
• a short list of action tasks to resolve and implement in the business over the next twelve months.

The business plan may also contemplate how and when the business owners may exit the business at a future point in time (your succession plan). The succession plan component of the business plan should highlight the need to focus on building value in the business over that period of time to ensure the business owner’s maximise their return on sale of the business.

The business plan will also become a very handy document to provide to a bank when a franchise business owner seeks finance from a bank.

Taxation

Taxation requires a specialised level of knowledge, meaning that franchise business owners should seek advice from a qualified accountant, particularly in respect of income tax. Generally, expenses that will be incurred in carrying on a business will be deductible for income tax purposes. However, some items such as the initial franchise fee are not deductible. Some business set up costs may be deductible over a period of five years rather than the year in which the costs were incurred. If seeking finance then the cost of interest incurred in acquiring the franchise business is generally deductible however we recommend you seek advice from a qualified accountant to ensure that borrowings are appropriately structured within your chosen entity to ensure interest deductibility. Borrowing costs greater than $100 incurred on setting up a finance facility may not be immediately deductible but may be deducted over the period of the loan or five years, whichever is shorter.

Most of the plant and equipment that you acquire as part of setting up your franchise business will be depreciable over a period of time for income tax purposes. However there are exceptions and again you should seek expert advice.

Franchise business owners may account for Goods and Services Tax (“GST”) on a cash basis if annual turnover is forecasted to be $1 million or less. Accounting for GST on a cash basis however, may not be advantageous if you provide customers with credit accounts with trading terms. This decision may have a dramatic effect on cash flow and again, you should seek advice if unsure.

GST is reported to the Australian Taxation Office by lodging Business Activity Statements (“BAS”). Many franchise business owners can prepare their own BAS after getting some training and advice from their accountant.

Financial forecasts and cash flow

As part of your Business Plan you should consider drafting a financial forecast, recording expected future revenues and expenses on a monthly or quarterly basis. You should then be able to forecast your expected future cash flows. Estimating expected future cash flows is fundamental to understanding the ability of the business to generate sufficient cash to meet the financial goals set out in the business plan. Similarly, the financial forecast and forecast cash flows will provide support for any discussions you may have with a bank for funding required to set up your franchise business.

Registrations

Setting up a franchise business involves a series of regulatory registrations. This should be done before any significant transactions are undertaken by the business entity. These registrations include:

• Australian Business Number (“ABN”)
• Tax File Number (“TFN”)
• Goods and Services Tax (“GST”)
• Pay As You Go Withholding (“PAYG”)
• Fringe Benefits Tax (“FBT”)

Your accountant can help you with these registrations. Your ABN and TFN will most likely be compulsory to operate your business. Registration for GST is compulsory if your annual turnover exceeds $75,000 (after 1 July 2007). Registration for PAYG Withholding is compulsory if your business employs staff and registration for FBT may be necessary if you provide any of those employees with non-cash remuneration.

There is also a statutory requirement to pay superannuation on behalf of most employees.

In addition to the registrations described above, your business will also need to keep appropriate records about its transactions. These records may support the information recorded in future income tax returns and any information shown to a potential buyer of the business.

Lifestyle

As a franchise business owner, you may start out believing that setting up a franchise business will provide a new freedom to make your own decisions and operate your business with the support and experience of the franchisor. All of this is true! However, along with being a franchise business owner comes the responsibility of operating the business, employing staff, meeting your financial commitments to creditors, the bank, the Australian Taxation Office and often a significant workload. While nothing may be more exciting than setting up your own franchise business and building the foundation for a successful business, be prepared for some hard work, particularly in the first few years.

I have discussed some important issues in setting up a franchise business. The choices you make as you set up the business will affect the simplicity of operating the business, taxation and your succession plan. Good luck and again seek advice from a professional accountant, you will be glad you did!

Author: Troy Wilson, July 2008

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