Making the Change from Employee to Franchise Owner
This article appeared in Issue 3#4 (May/June 2009) of Business Franchise Australia & New Zealand
The global financial crisis that started in the 2008 calendar year is emerging into a broader international economic slowdown in 2009.
In Australia, the slowdown has recently resulted in a marginal softening of the employment market as employers tend to either reduce their take up of new employees, or release employees from employment to manage costs.
For an employee, losing a job during the slowdown can be a devastating lifetime experience. However, I have also seen opportunities. In this article, I will explain how a client can turn the difficulty of losing work into a new beginning as a franchise business owner.
Let’s take David for instance. David is 55 years of age and worked as a manager in a large bank for just over 12 years. He was retrenched by his employer in March 2009 as part of a round of redundancies by the bank to save costs. Although he could retire at 55, he is not financially ready and David believes he has a good 10 years of working life left in him. However, finding a new job for a person at his skill level is difficult in the current economic climate.
While at the bank, David earned a salary of $75,000 per annum plus a small annual bonus. His employer contributed funds into an industry-based superannuation fund on David’s behalf at the statutory rate of 9% of his salary. David’s wife Maureen works part-time and they have two grown up children who are financially independent. Maureen is 53 years of age.
David and Maureen have assets including two cars and their home, which David estimates is worth about $750,000. David and Maureen have a mortgage on their home, with $125,000 remaining outstanding to another bank. He currently has $150,000 in his superannuation account and Maureen does not have much superannuation.
David would like to retire comfortably at 65 years of age. Before he was retrenched, he hoped to be debt free on his home by 65 and then to be able to afford the occasional holiday in Australia. His redundancy put a major wedge in his plan!
At the time he was made redundant, David received an employment termination payment, representing his unpaid leave plus a redundancy payment. His payment was comprised of 3 weeks of unused annual leave ($3,000 net of income tax), 10 weeks of unused long service leave ($10,000 net of income tax) and a ‘genuine redundancy payment’ amount which is partially tax-free, based on his years of service ($57,000 net of tax). Prior to being made redundant, David and Maureen also had $7,000 in cash deposits and bank accounts.
David had for some time toyed with the idea of starting his own business. It was not until he was retrenched and found it hard to get another job, that he seriously investigated the opportunity. As he wanted to avoid the inherent uncertainty of starting up a new business, he considered buying a franchise business.
David was especially interested in a particular type of ‘home services’ franchise as he enjoyed the idea of travelling from customer to customer. He thought he could run the business with Maureen, who could look after the bookkeeping. Also, David was not interested in employing any other staff members. After doing some research, he decided that he would buy an existing home services franchise business, including the required equipment (which he bought second hand) with an established clientele.
David talked to his accountant to get some advice about how much money he would need to buy the business and his likely financial returns. David also sought the advice of his financial advisor because he wanted to make sure that if he invested in a franchise business, he could continue to contribute funds into his superannuation fund. He also talked to a lawyer to get advice about the franchise documents and the business sale agreement.
David’s accountant established a trust for the purchase of the business. The total cash David and Maureen had available after David received his termination payment, net of tax, was $77,000. David felt he needed to ensure he had about $15,000 set aside over the next 3 months to cover their mortgage payments and basic lifestyle expenses. This left him about $52,000 to invest in his franchise business. David and his accountant prepared a financial forecast for investment in the franchise business.
Expected costs for investment in the business
- Buy existing home services franchise business -$30,000
- Buy second hand equipment - $10,000
- Legal, accounting and other start up costs - $10,000
- Total business investment costs - $50,000
David and his accountant calculated that David would not need to borrow any money to invest and operate his franchise business. This suited David’s financial goals.
The vendor of the business and David’s basic review indicated that the average weekly revenue of the business is about $2,000, or $100,000 per annum. David and his accountant then estimated his weekly operating costs.
Expected weekly operating costs for the business
- Fuel - $100
- Consumables - $50
- Maintenance and other miscellaneous expenses - $50
- Total weekly operating expenses - $200
This equates to annual operating costs of about $10,000 and David and his accountant therefore estimated the annual net income of the business is about $90,000 or $1,800 per week.
David also talked with his financial advisor to ensure his investment in the franchise business can meet his financial goals. Both David and Maureen will be employed by the new trust with David working full-time and Maureen part-time. This will mean the trust may contribute superannuation on behalf of both David and Maureen, which is a tax deductible expense for the trust.
As David is 55 years of age, he may salary sacrifice contributions from the trust into his superannuation fund on a before income tax basis, therefore reducing his taxable income on his remaining salary (employees currently over 50 years of age can do this up to the maximum allowable amount of $100,000 per annum until 2012).
At 55, David may receive a ‘Transition to Retirement Pension’ (TTRP) from his superannuation fund. A TTRP allows him to then extract a pension of up to 10% of the superannuation value while he works. In David’s case this would be up to $15,000 per annum as his current super balance is worth $150,000. This pension of up to $15,000 is then taxed at marginal rates less a 15% tax offset, representing a tax rate of 15% in David’s case. The top marginal rate on his remaining salary would be 30% plus Medicare levy, so this strategy represents a significant income tax saving.
As Maureen is not at TTRP age yet (55 years is the minimum age) she will not be able to extract a pension yet but she can still sacrifice her salary into super.
The remaining profit of the trust is paid as a salary to David and Maureen as employees of the trust. The trust must deduct income tax on behalf of David and Maureen before they receive their salary and income tax must also be paid on any distributions they receive from the trust. However, David and Maureen will benefit from the ability to split their income from the trust so that they can minimise their future income tax.
David’s financial strategy
By working with both his accountant and his financial advisor, David hopes to achieve his financial goals of both having the mortgage on his home fully repaid and to retire from work at by the time he reaches 65 years of age.
By the time David hopes to retire, David expects to make a comfortable capital gain on the sale of the franchise business. He will then be able to use the small business capital gains tax concessions (for proceeds of up to $500,000) and roll the entire amount he receives for the sale of his business into his superannuation fund, free of income tax.
By that time he will also be able to start to draw down on the funds in his super, again free of income tax. In this way he will build a larger base of funds for both he and Maureen to retire on, through creating capital value in his business.
Additionally, once the amount of funds in both his and Maureen’s superannuation accounts reach a level where they can manage their super at a cheaper cost than David’s industry fund, he then intends to roll his and Maureen’s entire superannuation funds into a new self managed superannuation fund. This will give David and Maureen control over their superannuation investments and flexibility in the use of funds.
The future for David
David has turned a devastating lifetime experience into a new beginning, by investing in a business. He has effectively used the capital amount he received on being made redundant by his employer and converted it into a capital investment in a franchise business.
By investing in a franchise business, he has also replaced the income he earned from his former employer with income from an established business model.
David has set his financial goals for himself and his wife and established a pathway to achieve those goals. He also received financial advice when he needed it, ensuring he could minimise his tax and maximise his superannuation.