Three Financial Risks every Franchise Buyer should be aware of

 

Every person who starts a business faces financial risk. It is possible that you might lose all or some of your investment, or may not make as much money as you hope for.

 

 

Every person who starts a business faces financial risk. It is possible that you might lose all or some of your investment, or may not make as much money as you hope for.

 

Of course, as a franchise buyer, you will be hoping that things will go well financially. But it’s still important to consider the financial risks and, where possible, take action to reduce the risk of a bad financial outcome. 

 

In this article we look at three risks every franchise buyer should consider, and how to reduce the chance of them sinking your business. 

 

What if you become unwell and can’t work?

What might happen to your business if you are unwell and unable to work for a period of time? While we all hope for good health, people do fall sick. If you’re a business owner, a serious illness might have financial consequences, especially if the day to day operation of the business relies on you.

 

For instance, a broken leg will put you out of action if you own a mobile service franchise that requires you to drive to customers. If you can’t get to customers there will be an immediate effect on your income.

 

By contrast, if you employ staff and have trained them to run the day to day operations, your business may be able operate without you, at least for a while.

 

The financial risks of a business owner falling sick are that revenue may fall and costs increase. This might affect the income you can take from your business, or the ability to pay essential expenses. So, it’s wise to consider steps to reduce the financial risks. 

 

Here are three steps you can take to reduce the risk that ill-health will hurt your business.

 

  • Set some profits aside for unexpected expenses. This means increasing the revenue of the business above the minimum needed to cover costs and your living expenses. 
  • Consider insurance policies that will provide an income if you are unable to work.
  • Train staff to manage the day-to-day work. A good manager or assistant will give you peace of mind if you’re unable to be at work. This may not be possible when your business is new, but it’s an excellent way to reduce risk give you some flexibility.

 

What if the franchisor has financial difficulties?

When you’re assessing a franchise, it’s important to bear in mind that there will be consequences for your business if the franchisor has financial difficulties. Your business can only continue to operate while the franchisor business is in operation. If the franchisor becomes insolvent you may lose your business.

 

But it’s not just franchisor insolvency that can affect your business. What if the franchisor faces financial difficulty and decides to reduce staff or services? Or they simply decide not to spend the money on franchise support? In both these cases your business might be affected by lack of support.

 

It’s mercifully rare for franchisors to fail. Still, when you’re looking at a franchise it’s important to assess the franchisor’s financial strength and their commitment to funding the franchise. This is especially true for newer franchises which don’t have a long track record in business. 

 

While franchisors are not required to provide financial information about their own business, there are steps you can take to assess their financial good standing.

 

  • When you complete your due diligence, perform a credit check of the franchisors entities. 
  • Ask existing franchisees about the franchisor’s investment in support and other services. 
  • Ask the franchisor to explain how the business operations are funded, their strategic plan and the support they expect to provide over the coming years. 

 

What if your business doesn’t go well?

Every franchise buyer goes into business with the expectation that things will go well. But the success of your business will, to a large degree, depend on your own ability to generate sales, operate at a profit, and pay your bills.

 

So, even though you are buying into a proven and profitable franchise, it’s important to pay attention to the financial aspects of your own business. If you don’t run the business well, you will pay the price.

 

Here are three things you can do to avoid your franchise turning into a financial nightmare.

 

  • Assess whether the franchise is financially viable. Before you commit, do your due diligence to assess whether the franchise can achieve the level of profit that you need to repay your debt and make an income. 
  • Consider the reasons your business might underperform as a result of what you do (or don’t do). For instance, lack of selling skills, inadequate financial backing and poor financial management can all cause financial problems. But with a bit of foresight each of these can be avoided.
  • Set goals for your business, and then monitor your results and take action to improve if you’re not achieving the results you planned for.

 

Buying a franchise can be a good financial decision, but as with all investments there are no guarantees. No matter how excited you are about owning a business, you’ll sleep easier at night if you spend a little time thinking about what might sink your business, and how you can reduce that risk.

Funding your Franchise Purchase

Below are some questions to consider as you explore your financing options:

  • Can you access the capital required to purchase the business?
  • Can the business generate enough revenue to make loan repayments from the outset (principal and interest)? If not, how will you fund these payments?
  • Can the business repay any funds you invest from your savings?
  • How many years will it take to repay any loans and your own investment in the business?
  • What will the consequences be if you are unable to meet your loan commitments or repay your own investment in the business? 
  • What action can you take to mitigate risks relating to any borrowings?
  • What benefits do you feel there are from investing your savings in this business?

 


Further Investigations

The following questions will help you with your Due Diligence and business planning. We recommend you consider them and make notes of your answers for reference. This information can come from your discussions with established franchisees, the disclosure document and discussions with the franchisor. 

Sales 

What sales have the other locations achieved in their first and second year in business? 

What is the pattern of sales that occurs in each month of the year? This will assist with your cash flow forecast.

Have you satisfied yourself that there is a viable local market? 

Marketing

Who are your competitors? 

How will your business stand out from the competition?

How do you intend to grow and develop the business? What will this cost?

What ongoing assistance will the franchisor provide with marketing?

Pricing 

What prices do competitors charge? 

How does your pricing compare with this?

Do you anticipate a need for discounting to attract members?

 

Franchisor Support 

What experience does the franchisor team have in supporting franchisees?

What will the franchisor do to help you grow your business?

What additional support is available if the business is slower to take off than you hope for?

What are the franchisors plans regarding recruitment of staff to support you and assist you in operating a successful business?

Fit-out costs

What steps are needed to ensure that the fit-out cost does not over-run?

 

 

 

Kate Groom is co-founder and director of Franchise Accounting and Tax. She has previously worked for franchisors and as a business adviser. Kate’s focus is on helping clients understand the financial aspects of running a business and on business planning and coaching. She is also a director of a number of ‘not for profits’.

https://www.franchiseaccountingandtax.com.au/