Sure, it’s a thrilling proposition to get in on the ground floor of what is hopefully a superstar concept. And it might be particularly lucrative if start-up costs (compared with those of long-established franchises) are low.
But of course, the downside is that some new franchises don’t survive the journey and are buried in unmarked graves along the way.
Before buying into a young or unproven system, it’s important to weigh the pros and cons. There are typically three types of businesses in this category, including established companies that have finally decided to franchise. The common denominator is that each is asking you to invest when there are few, if any, proven results from other franchisees who have gone before you.
Here’s a look at the most common types of new franchise opportunities – and the questions you should ask before signing up:
1. The mature company that is new to franchising
In this situation, the company typically has many years of experience and has opened a number of company-owned units. The people at the top know the business inside out and have worked out the bugs in the operating methods. The only transition the company needs to make is learning how to work effectively with franchisees rather than employees (and yes – there is a big difference between the two). This is typically the least risky young franchise to invest in, though it can still be a challenge to deal with growing pains.
Questions to ask:
- How do your training programmes for new franchisees differ from the previous training programmes for new employees?
- What support systems do you have in place for franchisees, such as manuals, DVDs or online intranets?
- Are you willing to treat franchisees as business owners?
2. The experienced franchise company that is changing its traditional operating model to something new
Let’s face it, most companies don’t change their business model unless they are in trouble. We’re seeing a lot of this in today’s market, especially with retail and discretionary-service operations, as the continuing recession hammers franchisees’ results. Though the company may have a big name in the marketplace and substantial operating experience, there is little assurance that the ‘new’ operating model will be a success until a group of new franchisees have put it to the test. You really need to consider the risk carefully, because an unproven model is just that.
Questions to ask:
- What research and testing supports the proposition that this new model will work better than the old one?
- How many units of the previous model have failed in the past two years?
- How many do you expect to lose in the next two years?
- What changes have been made to your marketing programmes to support the new model, and how will you allocate marketing support and money in the future between the new and old models?
3. The fairly young company that’s new to franchising
You’ve got to admire the bravado of entrepreneurs who have the confidence to start a company and then begin franchising with little or no practical experience. That’s how most of the big franchise companies got started – Ray Kroc of McDonald’s or Fred DeLuca of Subway are just two examples. That said, this is by far the riskiest venture to invest in. For every one success story, there are dozens of others that did not succeed.
As a new franchisee in a young system, you’ll have to suffer not only through your own learning curve, but the franchisor’s as well.
In fact, you may wish to find a different franchise with a proven track record or else to wait a year or two to see if the young company can create a reliable success pattern with other new franchisees. If you decide to take the risk anyway, the rewards for being a pioneer – namely, better economic terms and intimate relationships with top executives – can be great if the business succeeds.
Questions to ask:
- Do the company executives have previous experience growing a franchise company, or are they working with advisors who do?
- Does the company have sufficient cash reserves to weather any storms during its initial ramp-up period?
- How many training and support people does the company have and what is their background and experience?
- What kind of discounts on fees and other expenses are you offering to the initial group of pioneer franchisees?
What to consider before you invest.
There’s little doubt that the right franchising opportunity can be profitable and satisfying for the right entrepreneur, and the franchise industry appears eager to welcome and guide new owners.
Franchise ownership isn’t for everyone, however, nor is every opportunity a gold mine.
Here are four factors to think about before you make a decision:
- Do your homework on the franchise, including its expansion plans.
- Make sure the company provides support in the form of training, construction and marketing.
- Pay careful attention to the Franchise Disclosure Document. Carefully review the earnings claim (which franchisors don’t have to provide, although this lack of disclosure might raise questions) and the disclosure of the number of units, closures, and current and former franchisee names and contact info.
- Heed the plethora of fees and costs associated with the business, and pay attention to anything that might warn about hidden costs. Owners should determine, for example, whether vendor rebates are allowing franchisors to profit from supplies or equipment that the franchisee purchases. This is particularly important for new franchises – make sure franchisor costs are not being passed on to you.
Types Of Funding Available For Franchisees
If you’re interested in investing in a franchise, there are a number of funding routes available to you.
In South Africa, a franchise is considered a separate, specialised field of business and from a financing perspective is viewed differently to an existing business. It’s typically easier to get funding for a franchise as franchises have a proven product and they vet potential franchisees and offer support to new business owners. This support can include extensive training on running the franchise, branding and marketing, operational policies and procedures and a highly-tuned supplier network.
The reputation of the franchise will, to a large extent, dictate which finance options you choose and how easy it will be to raise the required funds.
It’s important to understand the cost of purchasing the business and the expected operating costs to work out how much finance you’ll need until the business starts to generate profits. Be clear about the upfront costs, including access to the brand, the market structure, start-up support and the set-up fee, which usually includes construction, equipment, stock and other necessary resources.
Consider the operating costs, which must include management service fees and franchise marketing and advertising levies. The franchisor will advise you on the time it should take for the franchise to start generating profits. Upfront costs plus operating costs are the total amount of finance required to purchase, set up and run the franchise.
What’s available for prospective franchisees?
Many of the large franchisors have their own funding mechanisms. These can range from their own established finance arm to funding assistance through partnerships with external lenders. Franchisors seldom fund 100% of the purchase costs; the amount of funding varies according to the size and reputation of the franchise and usually ranges from 25% to 75% of the costs.
Once a franchisor approves you as a franchisee, your chances of being approved for funding are significantly stronger. Some franchisors go a step further and suggest a business partnership with another potential franchisee who has good financial resources but less experience. Pairing experience with finance can be a useful option, but needs to be explored properly as it is a long-term partnership that must work for both parties.
Tandem Funding and Specialised Franchise Funders
South Africa’s B-BBEE legislation has led to a new option for franchise funding. It’s a particularly innovative way of quickly upskilling inexperienced potential franchisees. The franchisor funds the new franchise and retains ownership of the majority of shares in the business.
The franchisee initially purchases a small number of shares and is then mentored by the franchisor to set up and run the franchise. Profits are used to buy more shares until the franchisee has purchased all the franchise’s shares.
Specialist franchise funders are also a useful option. They typically consider a wider variety of franchises than banks and have in-depth knowledge of the industry. However, like other funders, their primary concern is to be sure that the loan will be repaid within the required period.
Franchise Funding from Banks
All of the large banks have specialised franchise funding departments. Their approval rate for funding franchises is generally higher than for independent businesses.
Banks will expect you to provide a sizable contribution toward the purchase of the franchise and funding is dependent on proof that the business will be able to repay the loan.
Other factors they consider are the location of the business and its proximity to competitors and catchment markets, your level of business experience, your credit record and the amount and type of support offered by the franchisor. The higher the level of support, the less the risk to the funder of the business under-performing.
If the franchisor is willing to enter into a joint venture with you to partially fund the purchase, the bank will consider this positively as it means the franchisor has a vested interest in helping you to succeed.
Government Franchise Funding
All of the government funding agencies offer franchise funding primarily to encourage black entrepreneurs to enter into the franchise business. For example, the National Empowerment Fund considers funding based on a minimum of 50,1% black shareholding, provided that the black shareholders are actively involved in managing the business.
They prefer to fund well-established franchises, fund up to R10 million and expect to exit within seven years, so you’ll need detailed projections to show that the loan can be repaid within that period. Ithala Bank considers funding for KZN-based approved franchisees who do not have collateral.
What funders expect from you
Lenders expect you to provide detailed information that will enable them to assess the risks of lending to the franchise. This means they require a detailed business plan, comprehensive and well- substantiated financial projections and full details of the franchise, its agreement terms and the levels of support they will provide. They will also need details of start-up costs; for example, construction, set-up costs, equipment and other resources required to establish the franchise.
Franchise lenders expect you to have concluded discussions with the franchisor and want to know that you have been approved. This pre-approval means that there is less risk to them. You’ll also be expected to provide feasibility studies from the franchisor.
The purchase of a franchise requires an injection of your own cash and if you are borrowing money, you’ll probably need to provide collateral. You’ll need a statement of personal assets and liabilities for each of the directors, a good credit record and detailed CVs of the owners to show the required business experience.
The more well-known the franchise, the higher the price, so do your homework before applying for finance. Understand the full cost of starting and running the business to make sure you aren’t in for future surprises. In particular, work out your current liquidity status.
Keep a small contingency fund available for unexpected expenses, so don’t invest all available capital in the venture.
Shop around. Compare finance institutions’ offerings to make sure you get the best deal. In the case of less expensive franchises, consider working with a couple of lenders; for example, an asset funder to fund equipment needs and a franchise funder for the start-up and working capital costs.
Factors To Consider Before Signing Up As A Franchisee
Franchising is a brilliant way to get into business with not many entrepreneurial skills as it comes with a roadmap to follow for success.
You’ve been considering entrepreneurship for a while, and now that you’ve finally raised some money and been approved for a loan, you’re ready to quit your 9-5 job to run your own business. You may even already have your eye on a particular franchise, but while franchising is considered an easier and more low risk way to get into business, are you suited to being a franchisee?
“The question is not ‘is franchising right for you’, but rather, are you right for franchising? Because if you don’t have the right attitude and skill set, it can be a very expensive mistake,” says small business expert and author Steve Strauss.
Franchising may seem like an easy way into entrepreneurship, but along with an established name and proven systems, come rules, regulations and little room for creativity. If you’re not ready to become a franchisee, but want to go into business for yourself, you may find yourself struggling to operate within the system’s blueprint.
Ask yourself these three questions before proceeding with the process of franchising:
1. Will you be able to follow the directions of the franchisor?
You’re buying into an existing and proven concept so it’s safe to assume that the franchisor knows best, and so you have to be open to learning and following guidelines for business success. If, for example, you have experience in advertising and think you have an improved technique of marketing the franchise, you may want to change the advertising material provided by the franchisor – don’t.
“Being a franchisee means following the directions of the franchisor, even when you think you know a better way,” advise experts from strategic and tactical advisory firm MSA Worldwide.
“In addition to initial training, you need to be prepared to accept coaching and advice from the franchisor on how you operate or market your location.”
2. Do you have the need to experiment?
Lou Groen may have had success in launching a new menu item that McDonald’s approved of in 1962, but not all franchisees are that lucky. Stick to the plan and limit deviations to the menu or anything that involves the customer experience.
If the franchisor’s concept doesn’t involve deliveries, offering them to your customers may cause issues for others within the franchise system. “If it’s not part of the franchisor’s concept, you’re deviating from the concept and therefore, no longer running your store as a franchise,” according to MSA. Franchising arguably limits innovation opportunities, so if you’re prone to implementing creative ideas and evolving business offerings based on said ideas, rather start your own independent business.
3. Are you a team player?
These first two questions you address should already lead to the realisation that everything you do affects everyone in the franchise chain. One bad experience at your establishment and suddenly, all the stores are affected by bad press or unsavoury social media attention.
“Other franchisees are relying upon you to offer to the consumer a consistent level of service, product quality, and brand message. You are going to have to work with others in the system in making decisions,” advise experts.
Remember that as part of a chain of other business owners, you may have to accept that majority rules when it comes to decisions where franchises do have a say.
3 Ways You Can Innovate And Improve As A Franchisee
Although your role as a franchisee isn’t really to innovate, there’s room for creativity if you go about it the right way.
When you signed on the dotted line after reading and agreeing with the franchise agreement, you knew that you were buying into a proven system where everything has already been thought out for you, and all you have to do is follow the formula for success.
But you’re a franchisee longing to put your own imprint on your business, and it may be frustrating to feel boxed in by a formula, while you’re bursting with new ideas.
“Franchising, by its nature, discourages innovation on the part of franchisees, who are required by their franchisors to follow very specific policies and procedures on exactly what they will sell, how they will make or deliver it,” notes Randy Myers, contributing editor for CFO and Corporate Board Member magazines.
This doesn’t mean your ideas will never see the light of day though. But before you approach your franchisor with your brilliant insight, consider the following steps that may well lead you down an innovative path:
1. Get the basics right first
Franchisors know that customers like consistency as it makes them comfortable and trust every location of their franchise they choose to visit. But, even the strictest franchisors get hungry for new ideas. It’s the timing that’s vital for your idea to even be considered.
“Most good systems don’t want new franchisees to even think about innovations until they learn the existing system inside out and prove that they can execute it like a star,” said Jeff Elgin, CEO of FranChoice, a network of franchise referral consultants. “At that point, they have become successful, their base is secure, and they have earned the right to consider innovations.”
It’s wise to ensure you’ve learned your franchisor’s existing business model before you suggest any improvements.
2. Do your homework
So, you’re doing well and you’re sure your idea will be welcomed as a crucial innovation to the franchise system – but research your proposal, suggests Kim Stevens, VP of Regional Development and Director of Franchise Awarding at Woodhouse Day Spas. “Especially if you’re suggesting something that would impact all franchisees, create a business plan before approaching your franchisor,’ she says.
It’s also good to have another look at the franchisor’s policy for accepting new ideas to ensure you’re prepared for tough questions before you propose your idea.
3. Speak to the right people
Elgin recommends you first identify the person at the franchisor’s head office who’s responsible for receiving new ideas. “Many of the ideas a franchisee comes up with will already have been proposed by another franchisee,” notes Elgin.
To avoid wasting your time, no matter how great you think the idea is, present it as early as possible before spending anything developing the idea.
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