Firm up the financials before buying a master franchise

If you're going to avoid any nasty surprises, it's important to thoroughly check out all of the financials before you buy a master franchise, says Brian Duckett, chairman of The Franchising Centre

Firm up the financials before buying a master franchise

Like it or not, when thinking about master franchising, you need to think about the numbers. It will only work if the franchisor, the master franchisee and the unit franchisees are operating sustainable businesses. That’s why any franchising plan starts with the figures.

Both sides should be committed to building a sound business over many years. This will involve working together with a common-sense approach to financing, training and support. The franchisor must be able to present the plans for its international development programme, supported by a detailed business plan. The potential master franchisee must then prepare their own business plan for the country.

Something you should specifically look for is what basic market research has been done by the franchisor on its product or service in the target country. If they haven’t done any, you should ask them why they think a franchised network can succeed there. And, even if they have done some research, the candidate will need to verify it when preparing their plan.

If the potential master is new to franchising, they will also need to build in some franchising research. For example, how does the franchising market for potential franchisees differ in their country to the franchisor’s home country? Is the proposed fee structure and rate of franchisee roll-out realistic? What about the costs of franchisee recruitment or local laws and cultural differences that may affect the operation?

The unit franchisee

Before worrying about the financials of the whole network, a master franchisee first needs to work out whether an individual franchisee can make a profit. Clearly there are some questions it needs answered.

How much will the franchisee need to invest initially – not just in the upfront franchise and training fees but in the acquisition of things like equipment, premises, vehicles and staff? Once they are set-up and opened, how quickly will sales start to come in and what will the associated expenses be? What ongoing fees will be payable to the master franchisee? When will the franchisee start making a profit and when will their cashflow eventually be positive? Will the business provide enough to repay loans, pay the franchisee an acceptable salary, generate a sufficient return on their investment and still leave money over to invest in the development of their business?

Most of the data will come from actual results achieved in the existing business in the franchisor’s home country but there will be many potential differences in the new market. These will include key ratios such as property costs, wage rates and fuel costs. It may even be impractical, for whatever reason, to charge the same level of upfront fees and ongoing management services fees as the franchisor charges in their home country, which will have an impact on both the unit and master franchisee’s calculations.

To complete the financial forecasts for a franchised outlet, the preliminary decisions are fed into the model – often using the proprietary software of the chosen advisor – and the outcome is assessed. Based on all current, accurate information and best-informed guesswork, does it look like an attractive option for a candidate who fits the desired franchisee profile?

All bets are off if the proposed structure won’t work for the individual franchisee because, if that’s the case, it won’t ever work for the master.

The master franchisee

What the master franchisee needs to know is whether there will ever be enough franchisees to cover the costs of setting up the franchising business in the first place and the support infrastructure that will be needed to support it. Unless they have done it before, they will definitely need help here because there are often many hidden – or just naively overlooked – costs that go with establishing a franchised network.

Over and above whatever country exclusivity fee has already been paid to the franchisor, these costs include territory analysis and demographic profiling; establishing and running pilot operations; preparation of the legal agreement; adaptation and perhaps even translation of the operations manual; adaptation of franchise marketing materials; franchisee marketing and recruitment; employment and training of experienced franchise support staff; and membership of the national franchise association. Obviously, this means considerable amounts of working capital are likely to be required.

In the first year of franchising, there will be few franchisees – probably five at best. They won’t all start in the first month and they will all be startup businesses. Their sales won’t be as high as they will when they’re mature, so the master’s total income from percentage management fees will not be very high. However, the master will need to provide all the necessary recruitment and support services to those early franchisees. If early franchisees are not supported and do not succeed, it will be hard to recruit others. If the master falls behind with their recruitment schedule, they may run out of money or lose exclusivity in the market. Their business will fail and so will those of the early franchisees.

On top of that, the master will need to recruit more franchisees next year so more must be spent on marketing and recruitment activity this year. That means even more money going out than there is coming in. All the amounts vary from business to business, which is why an experienced practitioner should be engaged to help with the plan. But it is not unusual for a franchising project to have a total funding requirement of £150,000 before it starts to make money.

It doesn’t matter what the overall funding requirement is, provided its level is known and funding is in place to cover it. What does matter is not knowing what the requirement is, then running out of money and leaving early franchisees exposed. The major clearing banks, certainly in the UK, are very supportive of franchising projects and they have their own specialist franchise divisions to advise their business managers on lending to both master and unit franchisees.

The relevance of all of the above is that it provides evidence and arguments when negotiating fees and development schedules with the franchisor. The franchisor may start by saying that they want a certain amount upfront, followed by another lump sum every time a unit opens and then a percentage of all ongoing management services fees received by the master franchisee. They will also say they want a certain number of outlets opened in a defined period of time.

If the master franchisee’s plan proves these figures to be unattainable then, at best, it will need to push for an adjustment of those figures to ones that will provide acceptable returns for all parties. At worst, it will result in no deal being done but will ensure the potential master franchisee saves themselves hundreds of thousands of pounds and endless heartache.”

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