If you are thinking about buying a franchise, the process can be daunting. Here are the essential things you need to know:
- Do you really want to own a business?
Even with the best systems in the world, business is hard work. You need to deal with dissatisfied customers, demanding landlords, late suppliers, paying staff and accruing tax. If that doesn’t sound like you, maybe owning a business is not for you.
On the other hand, if juggling is what you do best and you love the idea of dealing with all those issues at once, maybe you will thrive. Only you can know.
What I can tell you for sure is that a franchise is never an investment where you get to sit in the back with a newspaper and watch your staff make you money. It is always hard work. - What are the full upfront costs before you open?
This means everything, from the paper in the printer to the capital costs of a fit-out. What is absolutely everything you need to spend to open the doors. This includes capital costs (usually a fit-out, signage, special equipment and vehicles), stock, consumables, staff wages, training costs, rent and loan payments for the business, plus of course the franchisee fees, legal fees and accountants fees.
Do you also need to sign a lease, pay the landlord’s lawyer and provide a bank guarantee? Add those costs in too. Now add in working capital for a couple of extra months and you will have a clear picture of what your actual investment looks like.
Do your financial analysis on based on your investment being the total of all these amounts. - What revenue should you expect?
The single biggest mistake people make when buying a franchise is vastly overestimating what their revenue is likely to be. If you are buying an established business, check and double check the business numbers given to you to see if they are real. Sit outside the store for hours and count the customers in and out, and then compare that to the numbers you have been given. If it is a retail business, visit during both busy days and slow days.
If buying a new business that has never traded in that location before, try to find another franchise from the same brand in a similar location – same number of competitors nearby, same amount of parking or facilities, same layout. If you need customers to seek you out, really interrogate whether those customers will be there from day one or whether you need to build up your client base over time. Ask yourself if the business is actually easy for customers to use compared to nearby competitors. And after doing all this work, discount your estimate to account for risk. - What is your labour cost?
Work out how many people are actually needed to operate the business, for how many hours per day, in busy time and slow times. Food businesses take a LOT of staff, other businesses might be less. Never trust raw labour cost estimates given to you. Ask for a detailed spreadsheet showing all staff rosters over a week costed out by hour. Always include the manager’s and owner’s wages, because you are not there to work for free. Now check those numbers against Award rates. Build up a true cost of opening and operating, including doing all those jobs that happen when your business is not open.
- What are your other costs?
Next check the other costs, and verify the numbers. For lease costs, make sure you include outgoings and see actual rent invoices, not just the headline base rent. If the rent increases at 5% per year (which is not unusual) remember that CPI is at about 1%, so this is going to eat into your margins. For supply costs, again don’t trust raw estimates or percentages. Ask for a detailed spreadsheet showing all products for your first order, and then calculate out what turnover you need to use those products. Receiving payments by card or online? If so, get a true figure for fees involved. Add in the costs of a good bookkeeper and accountant.
- What can you change?
Now that you have worked out what the true cost is and have built up a financial model its time to dig into the Disclosure Documents, Franchise Agreement, Lease or associated documents and see what your rights are. What decisions are you allowed to make? Are you allowed to change your opening hours? Change your rostering? Change the products? Change your marketing? Change the pricing?
You want to own a business because you think you would be good at running a business. Franchisors will often give you very little scope to change anything in your business, which makes it very hard to adapt to suit local conditions. You need to be comfortable with the amount of flexibility on offer. - What can the Franchisor change?
What if the Franchisor changes the logo, products and direction of the brand – is that okay with you? They normally have the right to do all of those things, and when they do you will probably have to pay for all new signage or equipment. Think about seeking some limits on this, so that you are not being asked to replace brand-new signs. Also, when it comes to marketing do the franchisees get a say in how much is spent and what is spent on? You will be paying for marketing, but you might not see much value from a sporting sponsorship for a team based in a different city.
Similarly, if you have a lease, check what your Landlord can change too. There are normally no restrictions on them redeveloping the building or putting a competiting business right next to you. - Can the Franchisor open another Business near you?
Check what “territory” you have, and think about what it means for you. You might think that your business will grow with the local population, but the franchisor might plan on opening new stores nearby. If your business is special and unique in the area, people will come a long way to seek you out. If there could be one in every suburb, you are really only offering convenience. Try to get strong protection against competing against other stores in your own brand.
- What if you want out?
If you want to sell, can the Franchisor make it hard? Are extra fees payable? Are you committed to a long term lease with the landlord’s consent required to any sale? Liquid assets are worth more, and the liquidity of your business overall is defined by how easy it is to sell it to someone else. It often takes months and months to secure all the approvals to sell a franchise that you need from your Franchisor, landlord and bank.
If three competitors open nearby and your business is no longer sustainable, you might want to swallow your pride and just close your doors, but your Franchisor and Landlord will rarely let you do that. You need to understand just how big a commitment you are making. Ask the simple questions: If my business is losing money for six months, can I just close it and walk away? This will not normally be the case. - Can I renew at the end of the Term?
Your business might be going well for the first term, but unless you have certainty beyond that term then you need to make your full investment back, plus a profit margin and your own wage, within that period. Remember that if your business is doing well, the landlord will increase the rent at the first opportunity. The landlord might not renew your lease. You might also need to do a major refurbishment to your business assets just as you are starting to make money. Make sure your business model works and gives you an acceptable profit even if you want to close at end of the first term.
- What is the Franchisor’s take?
Now that you really know about the business that you are buying, ask yourself what the Franchisor’s cut is of all of your sales. Most Franchisors will take a franchisee fee as a percentage of turnover, plus a marketing fee, plus they might receive rebates from suppliers. They might also be vertically integrated and own the supply chain, and therefore the purchase price of products might include a profit margin for them at the manufacturing stage too. You might also need to pay to attend the Franchisor’s conference or events, or you might need to pay extra costs to promote your business locally under your agreement.
You need to add all these costs into your financial model and decide whether the Franchisor’s share is fair. Compare their share to the profits you can earn for your hard work, since you are the one taking the risk. - Ask Franchisees and Professionals for Feedback
Before you commit, but after you have done the homework above, take your financial model to some other Franchisees in the network, your lawyer and your accountant, and ask them to review what you have done. Yes, this will cost you money, but it will be the best money you have spent. Get real feedback from as many people as you can.
- Finally, Protect Your Family
Before you sign on to buy any business, ask yourself if your family is protected if the business goes bad. Do not offer up all of your family assets as security. The smartest franchisees put all their personal assets into separate ownership, and have little more than the business in their own name. They do not allow family members and spouses to provide personal guarantees.
If the worst happens, you will be liable for losses incurred by your bank, Landlord and Franchisor, and payments due to your staff and the tax office. You could lose a lot more than your initial investment. Get good advice on structuring your assets to avoid losing everything, or at least ensure your family won’t lose everything.