Starting a Franchise before Proof of Concept
This article appears in the July/August 2014 issue of Business Franchise Australia & New Zealand
Many business owners seek to franchise their business before the concept has been fully proven. This presents opportunities for buyers and sellers.
Our firm specialises in helping business owners get ready to franchise and helping launch start up franchises. As such we see a steady stream of entrepreneurs looking to take their concept to market using franchising as the expansion mechanism. Traditional approach dictates you should develop the proposition and test it in the market via company owned or privately funded units and only when successful with a solid trading history to then offer franchise opportunities. This is still a prudent approach and the recommended course of action for many startups. However, using franchising to test and refine the concept is also common practice and whilst it brings with it more risks for both parties it can also have significant benefits for both parties as well.
THE FRANCHISOR/ENTREPRENEUR PERSPECTIVE
So you have a great business idea or you have a small number of stores or operators trading successfully but you lack the capital, manpower or know-how to turn your early success into a larger network. Franchising may be a business model that can solve these challenges and facilitate faster market entry or faster growth than trying to do it all yourself or waiting for organic growth to fund your expansion. Let’s explore some advantages and disadvantages firstly for the franchisor.
Early mover advantage
In competitive markets where there is constant innovation by existing players and where there are always investors or commercial pirates looking to copy good ideas, gaining early mover advantage, rapid rollout or some quick scale of operations is a legitimate strategic play. The injection of external funding and human capital from franchisees can fast track your brand and footprint growth enabling you to claim your place in the market or take a category leadership position.
Accelerated testing and refinement of the concept
Franchising can provide more immediate points of representation to test or refine your concept in different customer segments or geographic markets enabling your customer proposition to be quickly fine-tuned. It can also enable your stores, your pricing and your marketing methods to be quickly modified to learn from customer feedback or buying patterns.
Smart use of limited resources
Even if you had sufficient capital to fund the full development and growth of your brand and network, diversifying your financial risk by taking on franchisee investors spreads the risk and enables you to use your money and human resources in priority areas.
Greater intellectual input
Often franchisees come up with the best ideas as they are fully committed to your business and they are working at the coalface with customers. So bringing some franchisees into your early stage growth phase can inject broader thinking and refinement of best practice.
Allows focus on being a good franchisor
Operating a company owned unit is often a smart way to test and refine the concept yourself. You have skin in the game and direct access to customers. However, if you do not have a large team or budget, focus on being a good franchisor is often the best approach. Let franchisees run the customer facing side of your business while you focus on developing the brand and network.
So as you can see, there are many positive reasons why a business growth plan may include early stage participation by franchisees. Let’s now explore some downsides:
Not only are you starting up your business in your industry (food, business services, fitness etc) you are also taking an early leap into starting a second layer in your business – the franchise. Here you are learning to operate a franchise and be a compliant and successful franchisor, which just adds to your duties and mind space. You are effectively starting two things at once. Some people can cope with this, others can’t.
Greater risk of failure
Put franchising aside for one moment – your business is either a concept or an early stage start up. Both are not fully proven so there is always underlying risk of failure. This risk is more about start up risk rather than franchising risk, but just because you launch some franchised units does not mean you have a proven concept or business model.
Need to give greater concessions and discounts
There is a buyer’s market for startup franchises but the prices and terms negotiated usually reflect the added risk the buyer is taking by joining early and helping you prove your concept. Many franchisors will give away the first couple of franchises for free or offer heavily discounted terms in order to attract buyers with the right attributes and risk appetite. Then, once the concept is been proven, market rated prices apply to the next round of buyers.
Risk of taking on the wrong franchisees
Long term success of a franchise is heavily dependent on the quality of franchisees. One trap start-up franchisors often fall into is they take the first person who comes along with money or who is prepared to give it a go. Just because they are willing doesn’t mean they are the right long term franchisees.
Learning on the job
Mistakes will be made because you are heading into unchartered territory and learning as you go. Some mistakes can prove very costly from a strategic and financial perspective, so you should try to identify and anticipate many of these issues to minimise these risks.
Failure is more public
When it is your own company then mistakes or failure can be dealt with privately. When you operate a franchise you have relationships and contracts with third party franchisees, people who have invested time and money in supporting your vision and business. So when there are problems, your franchisees will usually know about it and often insist on remedial action or compensation. In the modern world of social media a disgruntled franchisee can easily make public things they are concerned about or issues they have with you.
Starting a franchise at such an early stage is not for everyone but if you are considering it, here are some practical tips:
• Undertake proper research, analysis, planning and paperwork – do not do this ‘on the cheap’ or cut corners.
• Get professional help to test your concept, test your financial model, develop the commercial and practical aspects of your franchise and also properly prepare the operational and legal documentation.
• Like any start-up enterprise, have a clear plan with deliverables, milestones, review processes, budgets and contingency allowances.
• Have a mentor or honest advisor to challenge you and provide reality checks.
• Don’t blow all your money upfront on fancy offices, vehicles or overheads.
• Bias your initial spending to customer and marketing related activities – things that test your concept with customers and generate cashflow.
• Gear everything to the success of your initial franchisees – if they are not happy and successful your franchise will not grow.
• Make clear disclosures to your initial investors (franchisees) and do not pretend you are not a start-up.
• Ensure purchasers do their own due diligence and obtain independent legal and business advice.
• Ensure purchasers have sufficient money to ride out any delays or small failures.
• Don’t get caught up in disputes as they will distract you and bleed your cashflow – be commercial and solve disputes.
• Don’t be afraid to change things as you go – this is the refinement and proof stage of your business growth cycle.
THE FRANCHISE/BUYER PERSPECTIVE
Many of the advantages for a franchisor are disadvantages for the franchisee and many of the disadvantages for the franchisor are advantages for the franchisee. However, in general, if you are considering buying into a start-up franchise you need to understand the risks and weigh them against the rewards or premiums you may earn by getting in early and growing with the new group.
Make sure you do your own research on the industry, the business concept, the competitors, the people behind the franchise and the package of inclusions and exclusions you get under your franchise agreement. You may be buying a bargain and you may be able to negotiate other favourable terms but you need to think about “what happens if this doesn’t work” or “what happens if this takes longer to grow than you and/or everyone expects?” Do you have a fallback position, a second income or an ability to stick with it and ride out the bumps?
The flipside is to think about “what happens when the group is successful?” Plan ahead, possibly consider negotiating an option to purchase additional franchise units on concessional terms (a reward for being a foundation franchisee) or think about the timing of when you may sell your franchise in order to maximise the capital gain.
There have been many win/win scenarios where entrepreneurs have used franchising as the way of growing their brand and network before they have fully tested it themselves and in return many franchisees have made significant capital gains by joining groups at early stages then riding the growth wave in the market. Equally there are many who have not succeeded because they franchised too early or did not go about it the right way. Both buyers and entrepreneurs should carefully assess the advantages and disadvantages and make informed decisions. If in doubt, seek professional assistance.
Entrepreneurs take risks but the successful entrepreneurs are distinguished by the process, planning and people they put around them to systematically refine and grow their business.
CEO Consulting specialises in developing, launching and growing franchise systems in Australia and international markets. Services include Strategy, Feasibility, Analysis, Franchise Model Design, Franchise Development, Marketing, Sale & Purchase negotiations, Franchisor and Franchisee Mentoring & Support.
Robert is one of Australia’s leading Franchise experts and an authority on Franchise start ups. Formerly the Australian Head of Franchising for both ANZ Bank and Westpac as well as CEO of RAMS Home Loans.
For further information contact Robert Graham, Managing Director at CEO Consulting:
P: 1300 764 484