Is It A Good Time To Invest In A Franchise Right Now?

Is It A Good Time To Invest In A Franchise Right Now?


Vital Stats

  • Player: Prithivan Pillay
  • Company: Nedbank
  • Position: National Manager: New Business Development
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Given the state of the economy, is now a good time to invest in a franchise?

There is no doubt that people are nervous about the economy. Because of this they will obviously be hesitant to invest a large amount of money in anything, and franchising has certainly not been exempt from the current economic pressures. However, a franchise remains a solid investment. The industry is resilient, and the success rate for franchises remains at around 80%, which is far above the 20% success rate of a start-up.

What do you think of the state of our franchise sector?

South Africa boasts quite a mature franchise sector. Established and respected local franchisors generally have systems in place that are on par with international brands. I think this is evident from local franchises going into overseas markets. Nando’s is an excellent example. It has managed to carve a place for itself in very saturated markets, and that’s because the foundation of the business was sound.

Related: Nedbank Once Again To Provide Free Franchising Seminars

What do you think of the overseas brands that have come to South Africa over the last few years?

Some of these obviously represent great opportunities for prospective franchisees, but it is important to realise that a big international brand doesn’t guarantee success for everyone involved. A big overseas brand can still fail. And what proves popular overseas will not necessarily be popular here. Look at the frozen yoghurt market.

It is absolutely massive in the United States, but proved itself to be much smaller here. You can’t assume that the strength and recognisability of the brand will carry it through.

As a prospective franchisee, you need to make sure that the franchisor has done proper feasibility studies before plunging into the market.

What do banks look for when new franchisees approach them for finance?

As a general industry standard, a franchisee is expected to be able to provide 50% of the cost of a franchise in unencumbered capital. But this isn’t set in stone. For example, if someone is trying to finance their fourth or fifth franchise unit, they might not need 50% of the capital, since there is less risk on offering them finance.

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What are some of the common mistakes you see franchisees make when it comes to financing a business?

It is important to understand that the bank and the franchisor have very specific reasons for expecting 50% of the money in unencumbered capital. Gearing a business too aggressively is very risky. It is very difficult to make a success of a business and turn a profit if it is 100% financed.

It’s also important to remember that merely having the cash needed to buy a franchise is not enough. You will also need enough money to purchase stock, keep the business afloat and live off for a while. It can take a business a while to break even, and until then, you will need to be able to carry all costs.

How long does it typically take a franchise to break even?

That is difficult to say. It really depends on the nature of the business. Some break even within the first month, though most tend to take three to six months. Some can take as long as 18 months, though, so it’s important to have a very good idea of how long you’ll have to be able to carry expenses.

The prospective franchisee needs to speak to the franchisor and find out what the typical time to break-even is within the organisation.

How long does it typically take to see a return on investment?

Once again, it all depends on the nature of the business, but the average is around 36 months. What is worth keeping in mind is that many franchises will expect franchisees to refresh or revamp a store about four years after opening, so there is a high probability that you will need to put a lot of cash back into the business soon after seeing an ROI. You need to plan accordingly, as this can be an expensive process. A revamp can cost R1 million or more.

Related: Healthy Body20 Franchise Leads To Happy Hearts

What other advice do you have for franchisees?

Do your research. Don’t make any assumptions, and don’t just accept the word of the franchisor. Research the brand and find out who the directors of the franchise are, as it is important to know who the people are behind the business. Also, chat to existing franchisees. If eight out of ten grumble about the franchisor, there’s probably an issue in the organisation.

One should also do research on the larger industry. How saturated is the sector you’re trying to enter? A franchisor might allocate you a large area, but how many competing brands are already active in that area? Are there similar shops up and down the street? You need to be confident that there is real opportunity for your particular franchise to succeed in your area.

What about the financials of a store being purchased? How should a franchisee go about evaluating the numbers?

As a prospective franchisee, you should be provided with the financials of the business you want to purchase.

You should use this as a foundation to prepare your cashflow projections, ideally for three years. These financials together with your business plan can then be presented to your bank for assessment to determine the business’s viability.

How do you view the role of a bank within a franchise structure?

It’s in the interest of everyone involved — the franchisor, the bank and the landlord — to see the franchisee succeed. We are part of a chain of support that should be there to offer help if something goes wrong. If a business shows signs of distress, we want to help and see if the situation can be rectified.

What separates the great franchises from those that fail?

A lot of it comes down to systems and support. The whole point of buying into a franchise, after all, is to gain access to a proven business model, which means proven systems and support structures. Without those, you might as well open your own independent operation.

Great franchises are the ones that provide new franchisees with a lot of help and support, and have the systems in place to get new franchisees up and running with ease. Running a franchise organisation isn’t easy — there are a lot of functions involved — so you don’t want to buy into a small operation that’s being managed by a handful of people. They can’t possibly keep a handle on everything. You want to buy into an operation that has divisions focused on all the different functions associated with franchising, such as marketing and training.

Related: Xpress Operation On A Roll

What else should a franchisee expect of a franchisor?

A franchisor should have a solid understanding of the industry, and should be innovating and expanding at the corporate level. Don’t let the franchisor perform R&D inside your store. Concepts should be proven before they are rolled out to franchisees.

It’s always a good sign if the franchisor runs corporate-owned stores. By doing this, the organisation gains real insight into the issues franchisees deal with, and can also test new programmes before rolling them out to franchisees.

Remember this

Even though the success rate of a franchise is generally much higher than that of a start-up, it still doesn’t guarantee success. Not all franchises are created equal. It is important to do a lot of research before committing to a brand.

GG van Rooyen
GG van Rooyen is the deputy editor for Entrepreneur Magazine South Africa. Follow him on Twitter.

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