Why Franchising is Still One of the Best Investments You Can Make
McDonald’s first franchisee in Auckland, New Zealand, made his fortune out of the business, people queued up for Cheeseburgers and bands played. The franchisee bought other franchises and made his fortune.
Buying a McDonald’s franchise isn’t quite so lucrative today. I’m reliably told (by a McDonald’s franchisee) that you need four or five franchise units now to make decent money. Given that they will set you back well above $1 million each, that's a pretty hefty investment.
But is money the only measure of a good investment?
Only if you want a home for your money where it will provide you with a reliable passive income. The trouble is, with interest rates at all-time lows, you have to have a lot of money to invest to make a half-reasonable income. Even with as much as $2 million, you’d be lucky to earn $60,000 a year in a term investment. And you might have lost a third of your money if you had invested in the stock market before March this year (my condolences if you did).
What’s the best way to obtain financial freedom?
In his famous Rich Dad, Poor Dad series of books, Robert Kiyosaki says that the best way to obtain financial freedom is to stop working for someone else (a.k.a. making someone else rich) and get into business for yourself. Kiyosaki and his friend Donald Trump took that a step further by touting franchising as a way of getting into business for yourself but not by yourself, to quote the old cliché.
But going into business is not a passive investment. Meaning that it not only requires active involvement from you, it requires effective participation to be successful. I suppose that's why the majority of investors put their money in the bank, managed funds or the stock market, and in most parts of the world, fewer than one in seven people own their own businesses.
But those who go into business say they are in it for more than just the money.
Most talk about being their own boss, choosing their destiny and enjoying more freedom than they could in a job. That’s all fine and well, but many find the reality is quite different. They underestimate the time, effort and money it takes to build a successful business.
You have two options when going into business – buying an existing one or starting one of your own.
You may think if you’re buying an established business that the previous owner has done all the hard work. That’s one of the reasons you generally pay more – a premium known as goodwill – for an established business. But in my years as a business consultant, I have come across many buyers who thought they were onto a sure thing – only to find themselves stuck with obsolete systems, disenchanted employees, unsellable stock and deserting customers.
I have also come across some who bought great businesses but ended up driving them into the ground – simply because they lacked the qualities that brought success to the original owners. Just because a business is successful doesn’t mean it will be successful for you. Money can’t buy you a winning business. It can only give you the chance to keep from screwing up a winning business.
The only sure thing in business is that there are no sure things.
That is even more true of start-ups. Being successful depends on you having much more than just a good idea. You need a sound business model, product-market fit and the drive to build something out of nothing. You need to be ready to pivot in case your business model is not as sound as you thought it was, the market changes or a competitor beats you to the market.
And you need to be prepared to fail. Two out of three businesses do within the first five years, so the odds of success are against you.
A franchise is a sort of cross between a start-up and an established business.
Don’t have a great business idea, service or product? Don’t have any or much business experience? Then a franchise could be for you.
Unless you buy an existing franchised business, getting into a franchise will be a start-up – but a start-up with a difference. Instead of having to come up with everything you need yourself, you will be provided with all the trappings of an established business – a business model, brand, systems, training and support. You'll probably find it easier to obtain financing from banks, just as you would if you were buying a successful, established business.
What kind of return on investment can you expect from a franchise?
Unlike passive types of investments, most franchises allow you to benefit from three different types of income:
- Profitability (the money you have left after you deduct your cost of sales and business expenses from your sales revenue)
- Salary or wages (the money you can pay yourself regularly once you have built your business up to a sufficient size to support you)
- Capital gain (the money you can make as a result of your efforts in building up and selling your business over and above the cost of establishing and building it)
This means that an investment in a franchise has the potential to earn more than a passive investment – provided you choose the right franchise and put in the effort required to make it work. More on this later.
What does it cost to buy a franchise?
One of the criticisms of franchising, especially in the food and retail sectors, is that the fit-outs and other upfront costs demanded by franchisors are unnecessarily elaborate and expensive – and that results in higher debt and therefore greater risk for franchisees.
But that isn’t always the case.
The reason is that you expect the same experience and the same standards every time you enter a franchised store. And that’s one of the reasons why people shop or eat at these franchises, so franchisees generally expect – and receive – higher returns on their investment in their fit-outs than independent store owners. That's often why franchisees bought into these franchises in the first place.
Don’t franchise royalties eat into franchisee profitability?
A franchise royalty is a percentage of a franchisee’s sales revenue which is payable to the franchisor. It is often argued that royalties mean that franchises aren’t as profitable as non-franchised businesses, which don’t have to pay royalties.
Again, that isn’t always the case.
Most franchises enjoy certain benefits which non-franchised businesses – especially small stand-alone businesses – don't. Group buying power, for example, which brings franchisees' costs down. Business systems which provide greater efficiencies and stronger branding, which can command premium pricing, are other examples.
Do I have to be an entrepreneur to become a franchisee?
While some franchises require franchisees to have a level of technical ability, business experience and/or sales and marketing expertise, others can provide virtually anyone with the systems, training and support they need to start and run their businesses.
Having said that, there is a sliding scale in all franchises between entrepreneurialism and compliance. Although franchisees are legally independent business proprietors, they are also required to follow and comply with their franchisors’ methods and systems.
“Franchisees are often referred to as entrepreneurs, but they are really formula entrepreneurs,” says Michael Seid, author of Franchising for Dummies.
Is franchising a guarantee of success?
Buying a franchise could be the best investment you've ever made in your life. Many franchisees talk about their decision as being life changing. They say they would never have gone into business for themselves if it weren't for franchising. They say the time and effort they invest in their business doesn’t feel like work because they’re actually having fun in what they’re doing.
But anyone who has been following the franchising industry in the Australian news media over the past few years will know the answer to the question above. It must be remembered that any investment can be a risk if you don’t do proper due diligence.
And recognise that the success of any investment in a franchised business will always depend on your commitment, hard work and willingness to follow the franchise's systems and guidance.