What every franchisor must know

Franchising in Australia today is big business and everyone seems to want to get involved. Currently, there are more than 900 systems with a collective turnover greater than $120 billion. Even big corporations like ANZ are franchising. Meanwhile, small businesses have added nearly 100 new franchise systems to the Australian franchising landscape in the last two years.

So if you want to franchise your business, what are some of the things you need to consider? Let’s start at the beginning.

Can your business be operated without you?

If you’re thinking about franchising your business, be prepared to make yourself redundant. In fact, try to make yourself redundant anyway.

That doesn’t mean that you sell a few franchises and retire – far from it. When you franchise a business you escalate your commitment to the business, not decrease it. The difference is the nature of the commitment will change so that, as a franchisor, instead of spending every day working in the business, your job is to work on it – full-time.

Alternatives to franchising

The alternatives to franchising, as a growth strategy, can include:

· Company-owned chain using existing or externally sourced finance (across the whole business, or finance on a unit-by-unit basis, perhaps through selling equity in each outlet);

· Forming into a co-operative;

· Selling to a competitor with the resources and talent to grow the business effectively, or alternatively, buying out a competitor;

· Focusing on the manufacture and wholesale of goods and/or services, and outsourcing the retailing to a third party with greater expertise;

· Selling or licensing the rights to processes, trademarks or recipes that are unique to your business and which can be more effectively commercialised by another party (please note, however, that in some instances, licensing may well fall under the definition of a franchise under the Franchising Code of Conduct, and you should seek independent legal advice in this regard); or

· Servicing a national and multinational client base via the internet.

Until you’ve looked at these options (and others that might present themselves), you can’t be sure if franchising is right for you (and, even by the end of this article, you might still be unsure).

Understand your critical success factors

As part of your journey of discovery and learning about growth options for your business, you should also be re-learning what it is that makes your business work – that is, its critical success factors. Be conscious that whatever you perceive your critical success factors to be might, in fact, be different from reality. In other words, to get to the real truth, you’re going to have to do some research and analyse your business, your customers, your products and/or services, and work out just what makes your business tick.

Establishment costs and funding options

Entrepreneurs rarely stop to consider the cost of growing a business, which is a shame because, for many, it is their undoing.

The cost to establish the second site is rarely the same as the cost to establish the first. It may be dearer or cheaper, but it’s rarely the same.

On the one hand, the establishment cost may be cheaper as, with the benefit of hindsight, the business owner finds more cost-effective ways to do things that they weren’t aware of at the outset. They might also have improved their negotiating skills over time and have established relationships with suppliers that will give them better prices on some of the required stock and/or plant and equipment for the site.

Equity capital

Equity capital is an injection of funds provided by the owners of the business – whether those owners are the business founders, investment partners, or a combination of the two. Sometimes, investment partners will come from formal and informal social and business networks. They might even come from within the business itself through employees, suppliers or similar businesses.

Equity capital provides a meaningful starting point for a business, and makes it accountable and profit-focused. This is what any pilot operation must be in order for it to prove that the concept is replicable and that the profits generated will justify the risks taken by future incoming franchisees.

Debt finance

Cash flow, as one form of debt finance, is arguably the most unsophisticated and unstable form of financing available. Not only does it make it very difficult to identify true business performance, but any variation of income can have a catastrophic effect (one of the biggest causes of business failure is poor cash flow).

In a similar manner to equity capital, borrowings through traditional business loans, plus equipment leases, also make the new operation accountable and profit-focused. The difference is that lenders are only interested in the repayment of the principal and interest on the debt. They are less concerned with profitability than investors who might choose to forego short-term rewards for long-term gains. (Try telling a bank you can’t repay them this month, and see how interested they are in the long-term wellbeing of your business).

Maintaining accounts

Businesses that choose the flawed-but-common cash flow method of growth often fail to separate the performance of the different business locations beyond sales turnover. Cost of goods, labour and other business expenses are often not monitored separately – usually because all revenue goes into one large pot from which all costs are then paid.

For a second outlet to truly prove its performance, it should be treated as a completely separate entity. This means setting up its own bank account, and quarantining all transactions for the second outlet to that account.

Monitoring profit

By operating separate financial accounts for the existing and new operations, profit performance of both can be monitored. This is necessary to ensure that the performance of the initial outlet has not been adversely affected by the opening of the second, and that the second outlet is capable of producing real profits on its own.

There will usually be a lead-in time before the second outlet is profitable. The experience with the first outlet should provide an indication of this timeframe.

Charging ongoing fees

Every pilot operation must pay fees as it if were a real franchise. These fees must be shown in the profit and loss statement to determine an indicative net profit for a real franchisee – not because you want to use this information to create financial projections, but because you need to ensure that your business model is capable of generating real profits after franchisee fees.

For those potential franchisors, it may help to read about Franchise Council of Australia is a not for profit membership organisation that is the peak body representing the franchising sector in Australia.