Starting a new business is exciting, and of course franchises offer the support of a proven brand, but even if you’ve done it all before, it’s still possible to fall into some common financial traps that can delay, or in extreme cases even derail, your new business plans.
So, how do you successfully navigate that crucial startup landscape and avoid these potentially hazardous pitfalls? As they say, forewarned is forearmed, so let’s take a look at some common issues:
- Underestimating Initial Costs
One of the most common mistakes for new business owners is underestimating the total initial investment required. Let’s look beyond the franchise fee and consider:
- Fit-out: The costs of customising a store to brand requirements can be expensive and has risen on average around 12-14% year on year for the past three years. A comprehensive quote and an appropriate amount set aside for contingencies are both vital.
- Equipment: Make sure you understand all your equipment requirements, including items that are unique or specific to your franchise. Whilst equipment finance can be some of the easiest finance to obtain, don’t do it in isolation, as it’s often easier to obtain loans for both equipment and some fitout costs; obtaining fitout finance by itself however is often much more difficult.
- Stock and Inventory: Initial stock purchases can be significant, especially if the business relies on a wide variety of products.
- Legal and Accounting Fees: Professional advice is crucial! It will add to your initial outlays but shouldn’t be neglected. As a rule, don’t rely on advisors that are paid by others, remember they don’t work for you. A little money spent on your own lawyers and/or accountants up front can save you thousands of dollars down the track.
- Marketing and Opening Promotions: Launching your franchise will likely involve a marketing campaign to attract initial customers. Budget accordingly as there’s no point starting a business and not telling anybody.
Start by reviewing the Franchise Disclosure Document (FDD) and speaking with current franchisees to get a realistic estimate of costs, as well as references for professional services and even details about what stock to carry.
- Inadequate Working Capital
Working capital is essential to keep your franchise operational until it starts generating consistent revenue. Many new franchisees make the mistake of not setting aside sufficient funds to cover operating expenses during the initial months. Ensure you have enough working capital to cover:
- Rent and Utilities: These costs are unavoidable and need to be paid regardless of your sales.
- Loan Repayments: If you’ve borrowed money to start your business, don’t make the mistake of getting behind, particularly early on, as this can quickly spiral out of control.
- Employee Wages: Failing to pay your staff on time is a sure way to end up with an unhappy team (or no team at all), and that soon means no customers.
- Ongoing Inventory Costs: Maintaining stock levels will require regular purchases, and if you’re in a food related industry managing spoilage is critical.
A good rule of thumb is to have around six months’ worth of operating expenses in reserve, but the most important thing is having a realistic financial forecast so that you know how much ‘enough’ is for your business.
- Ignoring the Impact of Location
Location can significantly affect the success of a franchise. A prime location may come with higher costs, but it often pays off in increased foot traffic and more sales. Consider:
- Rent Costs: High-traffic areas typically come with higher rent, so weigh the cost against the potential for increased sales.
- Demographics: Ensure the local population aligns with your target market.
- Competition: Proximity to competitors can be both a challenge and an opportunity. There’s sound economic theory around groupings of similar businesses helping each other (like in food courts), but there’s also often a case for being the ‘only one for miles’.
Conduct your market research thoroughly and consult closely with the franchisor about the best possible location.
- Overborrowing
Most lenders look closely at ‘servicing’, which is how much the business can set aside for debt repayments. However, borrowers may sometimes overestimate their early revenue, or take the view that if a financier is willing to lend them a certain amount, then all must be ok. You should:
- Make sure that you understand your repayments and have accounted for them in your financial forecasts.
- Talk to your lender about the ability to draw down amounts as you need to, such as when dealing with progress payments for your builders, so as to avoid paying more than you need to.
- Make sure you understand the loan terms and what your lender, or lenders, are taking as security.
Perhaps most neglected, make sure you understand both the total amount of funding you need and when you need it. For example, you might have factored in a large landlord contribution to your forecasts, but those funds often aren’t received for 60 days or more, so plan ahead and make sure you don’t get caught short.
- Don’t forget the tax man
Tax obligations can take a significant chunk out of your revenue and can be overwhelming if not properly planned for. Franchisees should consider:
- Goods and Services Tax (GST): Ensure you understand how GST applies to your franchise operations, what will you pay and what will you get back? When?
- Income Tax: Regularly set aside funds for income tax payments to avoid a large, unexpected bill at the end of the financial year.
- Payroll Tax: Depending on your location and payroll size, you may also be liable for payroll tax.
Your accountant can help you to understand your obligations and plan accordingly.
- Overlooking the Franchise Agreement
The franchise agreement outlines some of the major financial commitments and obligations of both the franchisor and franchisee. Pay particular attention to:
- Royalty Fees: Regular payments to the franchisor, often a percentage of your sales.
- Marketing Contributions: Additional fees that go towards the franchisor’s national marketing fund.
- Renewal and Exit Fees: Costs associated with renewing the franchise agreement or exiting the franchise.
Seek legal advice to ensure you fully understand the financial implications of the franchise agreement.
- Insufficient Insurance Coverage
Insurance is often an afterthought, but shouldn’t be neglected. Depending on your business, you might need coverage for:
- Public Liability: To protect against claims for injuries or damage to property.
- Business Interruption: Covers loss of income due to unforeseen events that disrupt business operations.
- Product Liability: A must-have if you’re are selling goods that could potentially cause harm.
An insurance broker can be of great assistance when it comes to understanding your insurance needs and obtaining cover from the right provider.
And that’s it…
OK, that’s probably not it, but it’s a lot of good ground covered. Remember, when it comes to business a good plan is half the battle. So, keep your financial startup plan constantly updated, and maintain a watchful eye over the money coming into and out of the business from day one, keeping in mind that day one is the first day you spend a dollar, not the day you greet your first customer. Time to get busy!
Phil Chaplin the Chief Executive Officer of the CFI Finance Group, a specialist finance company servicing the franchise, accommodation, and fitness sectors as well as small businesses more broadly across Australia and New Zealand.
Phil has over 20 years’ experience in providing finance to businesses across Australia and New Zealand and has managed finance companies in the private banking sectors, he is a former chair of the Equipment Finance division of AFIA.