Why size doesn’t matter when it comes to franchising

Investing in a big-name franchise offers no more guarantees than buying into a smaller brand. That's why the things a franchisee should ask before investing money remains the same says Alex Littner, MD of Boost Capital

Why size doesn’t matter when it comes to franchising

The appeal of franchising for those with ambitions of business ownership is clear. Buying into a tried and tested business model makes sense for a would-be entrepreneur who dreams of running a company but lacks an original idea. Franchising is also ideal for business beginners who want extra guidance on running a successful enterprise.”

But figuring out which franchise system to invest in is not easy. There are currently 930 to choose from in the UK, according to the British Franchise Association (bfa). With so much choice, should you go for a well-known name – which probably comes with a hefty price tag – or a less established outfit that will likely cost less?”

Certain big names are strongly associated with franchising. Subway, the sandwich chain, is the second biggest franchisor in Britain after Dairy Crest, the milk delivery service, and more than 70% of McDonald’s’ UK stores are franchised. The advantage of allying yourself with these huge companies is that they are well-tested with an impressive success rate. Only recently, McDonald’s reported a 4% surge in like-for-like sales worldwide and it put much of this down to its greater focus on franchising its restaurants.”

In addition, established household names will typically provide franchisees with top-rate training and extensive support. They also have strong marketing know-how and consumers typically tend to favour big brands when deciding where to spend their hard-earned money. Finally, a franchise system’s reputation could also help when negotiating with deals with landlords, service providers and suppliers.

But such instant recognition does not come cheap. A Subway franchise requires a minimum investment of £100,000 and can be anything up to £250,000. Food and beverage franchises in good locations often cost up to £800,000 and some other contracts require franchisees to find more than £1m. Franchising fees and royalties for bigger franchise chains can also be higher than the average.

So, despite the security that might come from investing in an established brand, success is far from guaranteed. Franchisees with insufficient capital to survive before the business becomes profitable can end up struggling, while having the wrong skills or experience can also cause a big-name franchise unit to fail. And with size comes a certain degree of exposure – a scandal elsewhere in the company can taint perfectly functional franchise outlets operating under the same brand name.

Smaller can be beautiful

Not all franchise opportunities are well-known or require hundreds of thousands of pounds of investment. There are many deals available that only require a relatively low sum and which can offer a very strong return on investment for a franchisee. Developing a ‘greenfield’ franchise site or opportunity, which involves starting a new concept from scratch, can also be a less expensive way of getting into franchising. However, working out when the business may break even is likely to require at least a little educated guesswork, since there will be no trading history.”

How much you need to invest will frequently depend on the industry sector. The bfa puts the mean total sum invested on startup at £111,000 for a hotel and catering franchise but those in so-called personal services – dog grooming, personal training or children’s tutoring, for example – require a mean sum of just £36,000. Franchises in property services, including estate agencies, plumbing, cleaning, and gardening, come out at a mean of £52,000. It is also worth considering products or services that are not tied to a specific location or premises, which can be cheaper since they will have fewer overheads.”

Every franchise system must start somewhere – McDonald’s wasn’t always the world’s largest fast food chain, after all. It began its franchising journey in 1952, with its second franchisee only coming on board more than a year later. Getting in early on a franchise opportunity can be a great advantage, giving the franchisee a strong relationship with the parent company, the chance to enter new territories when the business expands and even the possibility of playing a part in how the group is shaped. “

But, as with any franchise investment, proper due diligence is essential. Some people prefer established franchises because they are afraid of putting money into an unknown name that could prove to be a dud or even a business scam posing as a legitimate operation.”

The first step is to check whether the company is registered with the bfa, which demands franchisors sign up to a code of ethical franchising. It’s then advisable to speak to existing franchisees but, instead of letting the company select them for you, make sure you choose the franchisees that you would like to speak to. Last but not least, ask to visit the head office and always take legal and financial advice before handing over any cash.”

Fundamentally, you should be wary of those franchises that are promising huge riches for little investment and minimal work. The harsh reality is that if a deal sounds too good to be true, it probably is.

Interrogate the franchisor

Regardless of whether you opt for a household name or a less recognisable brand, there are questions a would-be franchisee should always ask. The first things to establish are how many outlets are currently operating in the franchise system, how long the franchisor has been established and how much of its own money has been invested in the overall business.”

Other important details include the turnover and failure rates of franchise units; upfront costs and ongoing charges; the franchisor’s financial projections, backed up with evidence of accounts; and what support is given by the franchisor for things like marketing, advertising and bookkeeping. It is also worth checking whether the franchisor provides any financing arrangements and, if so, the terms of such arrangements. And, crucially, where can a franchisee turn for advice and guidance if their franchise is struggling?”

Exclusive purchase agreements are commonplace in franchising so you might also wish to check whether franchisees are obliged to buy stock or services from the franchisor and, if so, at what price. Finally, what are the opportunities for business growth and how would the franchisor help you achieve such an ambition? These are all questions that need to be asked as part of your due diligence process.”

Without a doubt, franchising can be a great way to start a business and, tellingly, our company finds itself dealing with more franchised businesses than ever before. The surge in franchising over recent years is typical of tougher economic times when people crave a proven business model which is less vulnerable than a regular startup, with many using redundancy money to get started. Since the 2008 downturn, the number of franchise systems in the UK has increased by 11%, according to the bfa. And, once many of these new business owners have experienced the thrill of running their own enterprise, they will never look back.”

But the old adage ‘buyer beware’ is worth bearing in mind when entering into franchising negotiations. Whether it is a big parent company or an ambitious minnow with growth potential, do your own research, take professional advice and ask as many questions as you can. If you make the right choice, it should be a relationship that provides you with years of happiness, professional fulfilment, and, of course, huge business success.”

Alex Littner
Alex Littner