Franchises have been around for awhile. The number of franchised businesses in various industries are at a high.
Written by Joel Ram
We have seen a lot of interest in franchised businesses compared to non-franchises. It is not all about wanting to be their own boss, which leads them to buying a franchise; most of the time it is the association with a successful brand that attracts them. There is a greater chance of success when a business is based on standard service delivery.
Many times people rush into a purchase without sufficient regard for the associated risks and how the move will affect them financially.
The four critical factors need to be taken into account before investing are:
- Meet all purchasing, employment and overhead cost obligations (including ongoing franchisor fees)
- Meet all financial loan repayment commitments
- Provide a fair market salary for the work carried out in the business by the franchise owner
- Provide a reasonable return on the money invested in purchasing the franchising business. The assessment of financial viability is a critical aspect of purchasing a franchise. It is important to focus on the hard, cold financial facts and detach oneself from the emotional appeal of owning a franchise, prior to signing on the dotted line.
Keys to an effective financial due diligence process on the purchase of a franchise:
- Do you have the capital or loan facility required to make the investment? What are you providing as security for the lending? Have the banks approved the lending?
- Educate yourself with the industry you’re going to invest in. Have you got the skills to run this franchise? Do you need to invest in training and qualification? One should be confident and informed about the industry you are investing in.
- Be prepared to pay for professional advice – As part of educating yourself and due diligence you will need to invest in a good professional team. Hire a good accountant and a lawyer. You may also need a valuer in some instances. Your accountant should be a member of either the Institute of Chartered Accountants in your country or CPA Australia, and should specialise in advising on franchising matters.
- Give yourself sufficient time for the financial due diligence. Gather as much information from the franchisor and get these analysed by your professional team. Too often purchasers get themselves signed up into a due diligence clause “10 working days from the time all information is received”. By this stage, emotions are running high with the expectation of operating a new business. There has been much time and money invested by both the potential franchisee and the franchisor in taking the arrangement to contract, and the expectations of settlement on the contract are high. At this stage, the pressure on the purchaser is often too intense to make a careful objective and thorough assessment of the financial viability of the purchase. The financial and non-financial due diligence should be completed before agreeing to go to contract.
- Invest your time – do a thorough research on the industry.
- Keep your options open – there are many franchise systems in operation which may be a good fit for you. Consider likely options and compare and contrast how the financial aspects of how various franchise models work. Decide what is important to you, list these factors and then rate each franchise you look at against your list. Identify the option which is likely to produce the best financial outcome and also tick the non-financial selection criteria boxes.
- Build a franchise financial forecast/model. Once you have selected your preferred franchise option, input the data you have gathered into a financial forecast, which projects every income and expense item in the business to determine estimated net profits. It should also model the movement of cash in the business. Profit doesn’t necessarily mean cash, and it’s important that potential cash-flow shortfalls are identified early. The assumptions used in this model need stress-testing to ensure they are conservative and realistic, as opposed to speculative and optimistic. It is worth preparing an “expected budget and cash flow” and “worst case scenario budget and cash flow”. If the results show that you do not have the reserves to handle the latter, a review of your strategy should be triggered immediately.
Does a franchise work?
At the end of the day, a franchise business is a well-structured and supported concept. It has several positive aspects. They have better branding, better buying power, better exposure and expectations of accountability from the owners.
Even though there are many franchise options which should produce good business outcomes, don’t believe it until you: do your research, model the financial outcome, undertake your very detailed analysis and importantly get the advice you need (not just the advice you want!). No two sets of financial arrangements will be the same and so you need to ensure that the franchise options you are considering will meet your financial needs.
Meet Joel Ram
Joel joined D’Mello Chartered Accountants as a director in September 2014. He attained his Chartered Accountancy in 2000 and provides a full range of accounting and business advisory services. Joel specialises in business development, valuations, due diligence and client business growth. He has looked after high net worth individuals and multi-entity clients for several years.