11 signs of a profitable franchise

By Sarah Stowe | 06 Jun 2016 View comments

Before you buy a business, ask yourself, what are the signs of a profitable franchise? 

This is an interesting question and with more than 80,000 franchised businesses operating in the Australian market, one that many people before you should have asked themselves.

Your ability to evaluate a franchisor’s offer before buying into a network is simply about assessing the risk you are taking.  About 80 percent of independent small businesses in Australia fail in the first five years and about half of those fail in the first 12 months.

So how do franchised businesses compare? Less than 20 percent of businesses that are part of a franchise network fail in the first five years.  But this is still a reasonably high rate of failure, so how do you mitigate against that risk and what should you look for when trying to determine if the franchise you are considering purchasing is profitable?

There is a range of decision criteria and working through the following checklist will assist you in your deliberations.

1. The business is a sound financial proposition

Ask the franchisor for financial dat,a preferably based on franchisees’ and corporate store performance. This may include some kind of business plan or a financial model and hopefully a profit and loss statement (P&L) for other units in the network. Break the numbers down so you can see how many products or services you need to sell, how many clients you need to service and what the average spend would need to be to break even after meeting all your overheads.

Not all sites or territories however will be equally profitable and the financial data you have been given may be an average across the network. If the business will be in a shopping mall, visit at different times of the day and on different days of the week to be certain there is enough foot traffic to generate sufficient revenue.What about operating capital and the operating costs?

This will vary from business to business so figure out how much money you will need to cover overheads such as rent, wages, cost of goods, utilities, loan repayments and franchise fees until the business becomes profitable.

Be realistic and don’t forget to factor in your salary during this time so you can maintain your standard of living and meet your rent/mortgage, school fees etc.

2. How long will it take to see the return of your investment (ROI)?

Simply, how long will it take to get back all the money you have invested including interest on any loans to purchase the franchise, your operational capital and a reasonable salary during this period? Generally the larger the initial investment, the longer the pay-back period.

An investment under $100,000 may return $50,000 to $70,000 annually whereas a $1.2m business may return $250,000 to $400,000.

As a rough guide to your of investment and ROI:

  • businesses under $100,000 may take 12 to24 months;
  • businesses from $180,000 to $400,000 may take 2.5 to 3.5 years;
  • businesses from $500,000 to $850,000 may take around four years;
  • businesses over $1m may take five or more years.

So it’s critical to ensure that the terms of your franchise agreement and your lease are sufficient to get back your initial investment, and hopefully to build some capital.

Franchisees typically spend seven years in a network which, if they are successful, allows them to realise ample goodwill value as well upon the sale of their business.

3. Successful franchise candidates get verification from other franchisees

The franchisor is required under the terms of the Disclosure Document to provide the contact details of all current and past franchisees. Get in touch with as many as possible and ask them all the financial questions noted. Then you can estimate how long it takes you to become profitable and at worst how long you could survive if the business didn’t turn a profit as quickly as you may have calculated.

4. Successful franchisees are risk averse entrepreneurs!

They want to own their own business and are prepared to work hard. However they mitigate against the risk of failure by buying into a proven and profitable business system where the franchisor has secured supply, refined the operational systems and processes, developed the brand and marketing and provides sound legal documentation to safeguard their intellectual property.

5. Profitable franchise networks tend to be highly prescriptive

In fact the higher the degree of prescription, generally the higher the profit: McDonalds is a case in point. So you would expect profitable franchises to outline exactly how to run your business; how training is delivered and at what cost; what ongoing support is offered; what marketing the franchisor does and how you would market your business locally.

You would expect to know what your responsibilities are: financial reporting, minimum performance criteria, attendance at conferences, operational and brand compliance.

6. Successful franchises provide comprehensive documentation: assess it

The documentation should include information about most of the following:

  • operations, training and procedures in manuals and/or a learning management system, not only for your induction and training on how to run the business but to hire, train and support your employees
  • brand guidelines and collateral so you can maintain brand consistency
  • marketing campaigns and collateral so you can engage in the requisite local area marketing and business development
  • a communication platform including for example a website and social media  communicating with customers; internet and possibly intranet allowing you to communicate and take direction from and report to the franchisor

7. Profitable franchisees are hard-working owner operators

Many good franchises are both labour and capital intensive requiring a total commitment especially in the early years. Successful franchisees know that an award winning franchisor or brand cannot make them successful. 

The best a franchisor can provide is a business model, the rest is up to the franchisee which is why you will see very successful multi-unit franchisees in the same network with franchisees who fail to thrive or even lose their investment.

Becoming a profitable franchisee is a serious undertaking requiring hard work, long hours and sacrifices for you and your family. But taking a medium to longer term view to reducing debt and building wealth first and then lifestyle can offer superior income, flexibility and security.

8. Successful franchisees are willing and able to comply

You have an opportunity to run your own business, but remember, you are buying access to the franchisor’s intellectual property to reduce the risk of establishing your own business. So your profitability is entirely dependent upon your willingness and ability to comply fully with every aspect of the franchise business as outlined in the operations manuals and the franchise agreement.

A franchise is not a democracy!

9. A great culture with passionate brand ambassadors

The most successful people work because they believe in what they do – money is a consequence of that endeavour rather than the driver. Belief in the mission or cultural allegiance drives performance. If you want to be really profitable it’s fundamentally important that you support and believe in the company’s values and are aligned with the founder’s vision.

Make sure the franchise matches your experience and skills, that you are sufficiently passionate about the industry, and that the brand and culture fit is right for you.

Your genuine commitment to the brand will drive your employees’ commitment, your customers’ loyalty and ultimately your profitability. While the culture may seem less important than a sound financial proposition you need to believe in what you do to be really successful.

10. Successful franchisees take professional advice

In the same way you wouldn’t make a major purchase such as a house without a building or pest report, it is simply good sense to take professional business and legal advice when buying a franchise.

The Franchising Code of Conduct requires franchisors to recommend that you seek legal and financial/business advice.  This highlights the serious nature of the agreement protecting both parties and allowing you to fully assess the representations made by the franchisor.

There is a section underneath this recommendation where – if you decide not to take such advice – you must sign to show you have declined to do so.

Whilst buying a franchise is less risky than starting your own business, there is no guarantee that your franchise business will be a success simply because it is a franchise. So get advice in writing from a lawyer and an accountant or business advisor who specialise in franchising and try to get a fixed fee quote for that advice upfront.

11. Profitable franchisees manage risk

Buying a franchise is an exciting opportunity to work for yourself. But there are over 1200 franchise systems out there and many fail to thrive, scale or capture market share. Understanding the decision criteria in assessing and researching each of these opportunities diligently reduces the risk of losing your investment. It also ensures that with hard work you too may join thousands of successful profitable franchisees in building future wealth and security for you and your family.