Is it a good idea to buy a franchise with a guaranteed income?

By Sarah Stowe | 29 Oct 2015 View comments

Did you know some franchisors offer a guaranteed income for brand new franchisees? Domini Stuart looks at what this involves and whether or not getting a financial security blanket when you buy a franchise is a good idea. 
Steve McCarthy had done his research and decided Cafe2Uwas the right franchise for him. He was confident he could build a successful business but, as he had never worked for himself, his one concern was managing the transition from wages to the less predictable income of a business owner.  
"The fact that Caf_2U offered a guaranteed income for the first two weeks gave me more confidence to take the plunge," he says.  "The deal was that, as long as I was working a full business hours, if my income for the day was less than $500 I'd get a cheque for the difference. In the end I only received three cheques because I made over $500 every other working day, but I really appreciated having that security." 

Income guarantee

Income guarantees are most common in the mobile service sector. They provide what is effectively working capital while the new franchisee builds up his or her business.  
"At their simplest, income guarantees are top-up payments made by the franchisor to a franchisee to an agreed level and with certain conditions," says Jason Gehrke, director of the Franchise Advisory Centre. "In the mobile service sector, this equates sales turnover to income as the business operat-ors usually have low overheads and are often selling only their labour." 

Retail systems occasionally make a similar commitment, though this is usually based on a different model and referred to as a profit guarantee.  

"Rather than being calculated on a weekly basis over the first few weeks, profit guarantees tend to be assessed at the end of 12 months of trading or at the end of the financial year," says Gehrke. "If the franchisee hasn't achieved the targeted profit amount the franchisor will pay the difference – again, subject to certain conditions." 

Franchise partners

Cafe2U attached an income guarantee to its business launch phase five years ago. 
"We wanted to help our new franchise partners to focus on learning the business and connecting with customers rather than being obsessed by the cash register," says general manager John Stanton. "Most new franchisees have financial commitments and this can have a significant impact on how they run their business. Our franchise partners know that, no matter what happens in the launch phase, we are underwriting them financially so those typical initial cash flow concerns are removed." 
Hire A Hubby introduced an income guarantee of $100,000 for the first year of business in 2001. Since then, the quality of their applications has improved. 

Build a business

"We need to attract people with the necessary hand skills ability as well as business nous," says CEO Brendan Green. "It only takes most of our franchisees about six months to start generating more work than they can handle so it's important that they have the capacity to add and manage staff to support their growing business. A lot of middle managers and white collar workers who fit this profile used to overlook our business because they didn't think they could earn that kind of money as a handyman. The $100,000 a year income guarantee flags that very clearly." 
Green learned quickly that the conditions of the income guarantee needed to be structured very carefully. 
"We had just introduced it when one young applicant told me it was a great idea, especially if you have Foxtel," he says. "He was silly, but he did us a favour – we tightened up our franchise agreement to make it clear that an income guarantee is not for the lazy. It's a safety net for franchisees who are taking advantage of all the support we provide and working hard during normal business hours to build their client base." 
Some franchise applicants are concerned that the work will dry up at the end of the guarantee period. 
"At start-up new franchisees are offered work from areas surrounding the territory they own," Green explains. "This helps to supplement their income while local area marketing initiatives are working to attract new customers. Over time, as recommendations and repeat business supplement the local area marketing, they establish a strong customer base in their own territory. Many of our franchisees won't need to take work outside their territory after about a year." 
Other applicants are worried that an income guarantee is just a gimmick designed to persuade them to hand over their investment dollars. 
 "To counter that, we also have a guaranteed buy-back," says Green. "As long as you're trading full time, following our marketing strategy and accepting all of the leads that come your way we guarantee to buy back the business in a certain period for an agreed amount. We're confident we're doing the best we can for all of our franchisees." 

Financial self-reliance

For a committed franchisee, an income guarantee can take the pressure of paying the bills until the business is generating sufficient income.  
"This is particularly significant for low-investment service franchises where there may be less focus on business plans and cashflow forecasts," says Gehrke. 
However, there's a danger that it could create a false sense of security. 
"If franchisees are conditioned to receive top-up payments from the franchisor when sales are low they might not understand just how financially self-reliant they need to become," Gehrke continues.  
There's also a risk that an income guarantee will not be set high enough to meet a franchisee's needs.
"A person who is used to clearing a salary of $1,000 per week may not realise that the promised sales turnover of $1,000 a week will not have the same spending power," says Gehrke. "Business expenses such as taxes could leave them with less cash for their mortgage repayments and other fixed living costs than they were expecting." 
Gehrke is also concerned that some franchise applicants overlook where the top-up payments actually come from. 
"It's very likely that the upfront franchise fee will be set to absorb the anticipated cost of income guarantee payments," says Gehrke. "For example, the franchisor might add $6,000 to the fee which, presuming the franchisee is earning some income, could fund an income guarantee of $1,000 a week for a number of weeks. I call it a "capitalised form of working capital" – and you might be better off keeping the money and controlling it yourself. My recommendation is to make an assessment of any income guarantee part of the overall decision-making process, but not the deciding factor."