Common reasons franchisees fail
There are various reasons why franchisees fail in business. The most common include financial issues, operational issues, personal issues and franchisor related issues. All these matters can adversely impact franchisee business performance and ultimately cause franchisees to fail.
Although some of these risks can be minimised under a franchise model the franchisee still needs to be aware of their occurrence and actively manage these risks at a local level.
Several common financial issues that can contribute to franchisee failure include:
• A franchisee not receiving the necessary financial and legal advice from inception and therefore gearing the business too highly by borrowing maximum capacity at the outset.
• A franchisee may not be able to produce prompt and accurate financial data so that timely management decisions about the business can be made.
• A franchisee may have initially paid too much for the business, particularly when the remaining lease term is short. Without a lease term there may not be a viable location to run the business from.
• A franchisee may have opened a greenfield/start-up site without sufficient financial analysis, planning and research. Greenfield sites require extra due diligence with extra planning. A detailed Business Plan should be prepared and include detailed financial statements together with a profit and loss, balance sheet, cash flow and funds statement so that an informed decision can be made.
• A franchisee may not be monitoring controllable factors such as labour costs, gross profit margins and average customer spend closely enough.
• A franchisee may lack a fall-back position and therefore may not have the ability to inject additional capital into the business to cover unforeseen circumstances.
• A franchisee may be drawing money out of the business for non-business related purposes, such as buying a new home, luxury motor vehicle or boat, which increase financial commitments while not adding benefit to the business.
• A franchisee may have requested a short-term facility, such as a temporary overdraft, when in fact they required a more permanent facility. This short term facility if not paid off can create hardcore debt and then put pressure on the business and its ability to access funds when required. An overdraft facility should freely move from debt to credit throughout the year.
• A franchisee may be experiencing falling business sales resulting in lower profitability and causing cash flow issues. This could mean they fall behind on loan repayments, rent, creditors, tax and royalties etc.
• A franchisee may be required to undergo a store refurbishment without having the cash or equity available in the business and without demonstrating the ability to increase sales and efficiency as a result.
• A franchisee experiencing financial distress may not keep open communication with their bank and franchisor. If a franchisee chooses to ignore or not return calls this could hinder all parties’ ability to achieve the best possible outcome.
Operational issues that can impact franchisees business success can be both internal and external to the business. The following operational issues can occur:
• External issues may include a competitor opening nearby within their area of influence or the failure of a major supplier without a readily identifiable substitute product being available.
• Internal issues may include overstocking, particularly in a seasonal segment or location therefore impacting the businesses cash flow and profitability if stock is sold at below cost.
• Other internal issues include insufficient research and due diligence completed by the franchisee to understand the business and its competitive forces, customer preferences and expectations.
• Franchisees often do not plan their local area marketing activities well and they either do not spend enough or spend in the wrong areas so sales and branding is not generated.
• Multi-site expansion can impact the business if a franchisee doesn’t maintain proper control when moving from single store to a multi store operation. Many franchisees focus on the new store without maintaining sufficient control over the existing business and therefore may not properly accommodate for the increased labour costs to replace their own labour when they move out of the first store. It is also likely the second store will take time to build up enough business to reach breakeven so additional capital may be required.
• Multiple stores/sites also require greater leadership skills of people than a single store/site and sometimes franchisees overlook this aspect.
Sometimes issues deemed to be personal in and out of a franchisee’s control can adversely impact a franchisee’s operations.
Some common personal issues include the following:
• A franchisee may not be spending enough time in the business.
• A franchisee may not recognise that they have a problem and not willing to ask for help until it is too late.
• A franchisee may become seriously ill or involved in a serious accident.
• A franchisee may divorce or separate from their spouse.
• A franchise partnership may experience conflict in their business partnership.
• A franchisee’s partner may leave their paid employment to work in the business before the business is able to support them.
• A franchisee that has worked long hours for a considerable amount of time can become burnt out and lose interest in the business. This is particularly true if they are not making sufficient profit to reward their efforts. They may feel they are just working for the franchisor, landlord and the bank.
Lastly, there are also a number of franchisor related issues which can impact a franchisee’s performance. Speaking to existing franchisees within the franchise system should always form part of a franchisee’s due diligence when buying a franchise. This will provide some insights into current franchisees relationships with the franchisor, how happy franchisees are and the level of support provided by the franchisor.
Franchisor issues that could affect franchisees include the following:
• The franchise system has a high number of existing businesses for sale.
• The franchisor is experiencing high head office churn resulting in a potential reduction in support to franchisees.
• The franchisor is experiencing cash flow and profitability issues.
• The franchisor has insufficient capital to fund expansion and system development and is reliant on selling new franchises.
• The franchise system has a high number of unhappy franchisees and the franchisees are not making money.
• The franchisor is desperate to sell new franchises therefore lowering the quality of franchisees and locations selected.
Westpac has supported the franchise sector in Australia for over 20 years. The growth of a specific franchise system is supported by providing streamlined processes for lending, as well as access to other lending transactional solutions. The bank also has a national network of franchise specialist business bankers who are able to deal with specific day to day needs of the franchise customer.
Labrina Tsekouras is the Westpac Senior Business Development Manager for Victoria and Tasmania and specialises in the franchising sector.
Contact Labrina at:
P: 0418 246 903