- Player: Prithivan Pillay
- Company: Nedbank
- Position: National Manager: New Business Development
- Visit: www.nedbank.co.za
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.
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.
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.
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.
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.
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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