Over 40% of new business owners and franchisees do not know what due diligence is: Research

The majority of new independent business owners and franchisees rely on their “gut feel” when setting up or buying their business and close to half of these business operators are not familiar with the term “due diligence”, according to research undertaken by Griffith University’s Asia-Pacific Centre for Franchising Excellence.

Just over 600 current and former franchisees and independent small business owners were surveyed as part of the research, which forms phase two of a larger study into due diligence conducted by the centre and researchers from the University of New South Wales, and supported by CPA Australia.

The first phase of the research, released in July 2015, involved interviews with 60 independent business owners and franchisees.

It found the level of due diligence undertaken by operators before buying or establishing a new business in Australia is “unsophisticated” and most business owners have a “naïve” appreciation of business.

Phase two of the project aimed to add quantitative data to these findings through an online survey of 610 business operators.

Among those surveyed, 42% said they had either not heard of the term “due diligence” or do not know know what the term meant. Another 39% of survey respondents said they have “some” understanding of what due diligence involves and 19% said they clearly understand the concept.

The research also revealed business owners that do undertake due diligence before buying or establishing a new business do not spend large amounts of money on the exercise. The time spend on undertaking due diligence was also found to be “relatively low”, although prospective franchisees were found to be consulting more widely than owners of independent businesses.

Around one third of business owners surveyed said they consulted with an accountant, lawyer or financial adviser prior to purchasing or starting a business.

The average total cost of due diligence carried out by current and former franchisees was in the range of $2500 to $2700, with the average spend for owners of independent businesses coming in at between $1500 and $2290.

Professor Lorelle Frazer, director of the Asia-Pacific Centre for Franchising Excellence, told SmartCompany the apparent lack of time and money spent on undertaking due diligence was the most surprising finding to come out of phase two of the research.

“Business owners are often so concerned to know how much it will cost to buy or start a business, which is a big investment, that the last thing they invest in is education leading into it,” she says.

While Frazer says there are some free resources available to prospective business owners, including from governments, it is more often the case that these individuals are missing out on specific, expert advice that applies directly to their business.

“Each business is unique,” Frazer says.

“They need to do their own personal due diligence for their particular business, to make sure they are in the right market, understand the competition and if they are paying the right price for the business.”

Frazer says one of the concerns in the franchising sector is the tendency for prospective franchise owners to seek general professional advice, as opposed to specific advise about franchised business models.

Peter Strong, chief executive of the Council of Small Business of Australia, told SmartCompany the absence of due diligence is a common problem in the small business sector among prospective business owners.

“All the excitement, trust and optimism should never be a replacement for due diligence,” he says.

In particular, Strong says it is essential for all business owners and operators to pay careful attention to the contracts they are signing when establishing their businesses. This may include lease contracts, as well as supply contracts with much larger businesses.

“We all do it when we buy a house or a car. It’s the same thing,” he says.

Future research

While Frazer says the Centre for Franchising Excellence has already made some recommendations to the franchising sector about possibly extending the amount of time franchisees have to consider a purchase decision, she says the centre hopes to continue its research into the area of due diligence.

In particular, the centre is keen to investigate the relationship between due diligence and business performance, which until know has only touched on the business owners’ perception of performance as opposed to financial metrics.

“The perceived performance among franchisees was significantly higher or more positive than current and former independents but we need some hard data,” she says.