Show me the money! Tips & Traps when buying a Franchise

Suzanne Jarzabkowska | CEO and Partner | DCS Group
Show me the money! Tips & Traps when buying a Franchise

Show me the money! Tips & Traps when buying a Franchise

Franchisees are first and foremost entrepreneurs. People with a passion to own and operate their own business and the tenacity to weather the challenges for the rewards they seek.

What differentiates them from other business owners is their appetite for risk.

The facts are that four out of five independent small businesses fail in the first five years and almost half of them in the first year. Franchisees look to reduce their risk by buying into a proven business network. Comparing the failure rate of about one out of five franchise business failures in the same period certainly supports that belief.

However simply buying a franchise doesn’t ensure your success. Some franchisees do very well and others less so, even in thriving networks. Ensuring you’ll be one of the success stories starts now as you assess the franchise opportunities available, gather and analyse all the information you can get, weigh up the risk and make the right decision for you.

How much money do you have to invest?

This might seem obvious but work out how much capital you can raise. This may be borrowing against the equity in your home, loans from financial institutions or family or using your savings. Determining how much you can really afford will narrow down the choice to what businesses are available in that price bracket.

What are the real costs including operating capital?

Operating capital is the money needed to meet the operational costs until the business is profitable. This includes rent, cost of goods, wages, loan repayment, utilities and your wage as an owner operator so you can cover your living costs such as a mortgage or rent, car, credit cards etc. Businesses vary but it may take many months to turn over enough to match your current income. You need to be sure that you will survive, so do your research and ask other franchisees in the network how long it took them.

The fit out is another cost which can escalate, and you need to ensure any possible increase doesn’t eat up your operating capital. Check with the franchisor whether the fit out costs are fixed or just estimates and contact the fit out contractors directly to verify how the contract is managed.

Do the numbers work?

Ask the franchisor or recruiter for a business plan or a financial model preferably based on trading data (P&Ls) from other franchises and corporate owned businesses. You need to calculate how many products or services you need to sell, how many clients you need to service per day, and what the average spend needs to be to break even after covering your overheads. Examine the operating costs to ensure rent, labour and the cost of goods are a viable percentage of your turnover. Analysing this information is imperative so you can figure out if the business will work financially.

How to calculate your return on investment (ROI)

Generally, the larger your investment, the longer the payback period will be. This includes interest on your loans and the operating capital, noting you will need to factor in a reasonable salary during this period. As a very rough guide on investment to return period:

  • Under $100K - 12-24 months
  • Around $180-400K - 2.5 to 3.5 years
  • From $500-$850+ - 4 years or more
  • Over the $1M+ - 5 years or more

The higher the investment, the higher you would generally expect your annual reward, with businesses under $100K bringing around $50-80K and $1.2M+ business investors seeing returns of around $250-400K per annum. Typically however, businesses have a ramp up period, so meeting all your obligations and making a living wage in the first year will provide the foundation for more rapid growth in the next three to four years. Understanding this will ensure the (typically) five to six year terms of your franchise agreement and lease are sufficient to get your initial investment back, plus the eventual goodwill when you sell.

What kind of business should you look for?

The most important aspect of buying a franchise is the clear understanding that the successful franchise requires an owner/operator to be truly profitable. So, your investment is not just your money, but your time. Is this a seven day a week franchise, such as a fast food business; will you need staff; will family members work in the business and be giving up a job? Or are you looking for a part-time opportunity such as a work from home offer; do you want a mobile rather than a storefront business, or maybe a B2B working only Monday to Friday? Running your own business impacts your lifestyle and your family need to be on board with how the sacrifices now will bring a long-term reward.

Other factors to consider - location, seasonality etc.

Will the site you are considering generate enough revenue; is there enough foot traffic to make sufficient sales? Go to the location and literally count the number of people that walk past your intended site at different times of the day and on different days of the week.

Is the business seasonal; do sales vary significantly throughout the week/year and are they consistent throughout the day? This will affect your staffing levels, wage costs and you will need to consider whether a potentially seasonal business, such as icecream makes enough money in the summer to cover the possible lower sales in winter months in colder climates.

Where your business is located can also affect profitability with significant variation between sales in units in the same network. So, for mobile or bricks and mortar franchises, go to the site or suburb where you want to operate and assess: are potential customers in the area, do you have an exclusive operating or marketing territory and who are your competitors? How far will you have to travel from your home? An outlet in your area has advantages of reduced travel time and of being part of the community and market you know. Look carefully at the factors that have made the most successful operators profitable and what may be the factors for those who are less so.

How do you know you’ll enjoy the business?

Try and find something you are passionate about, that matches your experience and skills. Franchisees typically spend seven years in a network, so loving and believing in what the brand offers is paramount to your success. Meet the franchisor and speak to other franchisees - you want to work with dedicated people you respect and who are as hardworking as you are. Understand that your compliance to the franchise operating systems and your obligations to the franchisor are also vital to your success. You want to run your own business, but the reason you are buying into a franchise is to reduce the risk of establishing your own business.

Get independent verification

Research the business online, go to several outlets and see the business in action and most importantly speak with other franchisees and even former franchisees. They can tell you about training, what it covered, whether it was available for their employees, any upfront or ongoing costs.

They can explain how long it took to become profitable, how much operating capital they needed, about seasonality, rents, staffing and how the franchisor is to deal with. And speak with the franchisor about any concerns; ask questions about their business plans and the level of support they give franchisees. Understand their vision for the brand and the culture of the network to see if your values are aligned.

Check out the Operations Manuals

These should tell you exactly how to run your business: training, costs, ongoing support, what marketing the franchisor does; what marketing collateral is provided and how will you be able to use that to market your business locally. Many franchisors are reluctant to provide you with a copy of the Operations Manual before you sign the Franchise Agreement because it contains confidential information. However, ask to see it at head office and note the sections relating to performance criteria and legal obligations.

Take professional advice

You wouldn’t buy a house without getting a building or pest report or retaining a conveyancer or lawyer to handle the contracts. Buying a franchise is as big a decision – so protect yourself and your investment with the relatively small amount it costs to engage professionals. The Franchising Code also recommends this in their Statement of Independent Advice, so get the business and  legal advice in writing and try to negotiate a fixed fee for the services.

DCS Group CEO and partner, Suzanne Jarzabkowska, heads up the multi-disciplinary franchise team at DC Strategy. She has achieved successful outcomes as an entrepreneur in the private sector, in the international NGO sector and in the franchise industry.

Suzanne specialises in organisational behaviour, performance and change management, franchise development, risk management and conflict resolution. She writes and presents widely domestically and internationally advising franchise networks, private enterprise, public sector and not-for-profit organisations.

suzanne.jarzabkowska@dcstrategy.com