The National Bank's advice on choosing a franchise

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If you displayed symptoms from early childhood graduating from a single-minded, petulant little child and maintaining that lack of endearment for authority, finally maturing into one of tomorrow's budding entrepreneurs – then I suspect franchising is not for you!

So, where do you start your search for a business? The daily newspapers are an excellent source of initial information with many private vendors, real estate agents, accountants and business brokers touting their wares. Equally helpful, is the ever-expanding array of dedicated websites advertising businesses for sale. And if that wasn't enough, you can now employ a personal business broker to procure a business for you. For those who favour the direct approach, I would even suggest shortcutting these routes and propositioning the owner of the business you are interested in. You'll find everything is for sale at a price! There is another option to buying an existing business and that is to buy a turnkey operation - a new franchise in the form of a ready, tailor-made business that has yet to open its doors. For access to these opportunities you have additional resources in the form of various franchise magazines, franchise consultants, franchise brokers or direct access to the franchisors themselves.

Turnkey operations can appear a daunting prospect when compared with the proposition of buying a pre-existing franchise, due to the associated risks of the unknown. Buying a turnkey business is a bit like buying a new car - as soon as you take possession you can expect the immediate resale value of the business to plummet. The good news is that you will have saved considerably in terms of the amount of your investment. The only 'goodwill' factor in the purchase price is usually the franchise fee itself, whereas goodwill in an existing business is often reflective of the reasonable certainty that it will be profitable from day one.

There is no question that franchised businesses, and franchised cafes and restaurants in particular, are in huge demand because they offer the security of a (hopefully) proven operating system. If the purchaser becomes a good franchisee and rigidly follows that operating system, the financial rewards are much less uncertain than those of a non-franchised business.

Herein lies the first warning sign for would-be prospective franchisees. Referring to your personal development, if you have so far transitioned from single-minded petulance in early childhood, to healthy disrespect for authority in adolescence before finally blossoming into a budding entrepreneur in adulthood, then franchising is probably not for you. The ability to follow a system (often without question) and the ability to do so with enthusiasm and satisfaction are fundamental attributes in a successful franchisee. If you don't have these attributes you should consider buying a non-franchised business where your individual entrepreneurial skills and talents can flourish under your own direction.

Tip No 1: Consider the merits of a franchise system that is supported by all the banks – they are unlikely to be wrong!
Banks, traditionally the embodiment of conservatism when it comes to lending and security for such advances, tend to prefer franchised businesses to non- franchised businesses. Invariably, each bank will have its own particular preferences when it comes to the franchise systems it supports. These preferences are based upon the depth of knowledge it has accumulated on each franchise system. This knowledge may have come as a result of exposure to a number of individual operators within the franchise. Banks find it easy to access their financial performance, determine the franchise system's key performance indicators and review financial results for each of the individual franchisees. If the franchise is international, the bank may find its success overseas reassuring. The bank's objective is to construct a risk profile and a financial model for any given franchise on the basis of its sales data, in order to accurately predict financial performance. The National Bank of New Zealand is a leading organization in this field.

Tip No 2: Surprise! Not all vendors tell the absolute truth when they are selling their businesses. However, some aspects of the financial information provided are more likely to be reliable than others.
If the business is an existing franchised business, then a prospective purchaser will have access to sales information through the vendor. Now, given that most franchisor's derive their income from franchise fees (royalties), and that the calculation of the amount of these royalties is usually expressed as a percentage of sales, you can be absolutely assured that the franchisor has a cast iron guarantee that ensures sales are properly recorded. The advantage for the prospective purchaser is that they can rely upon this sales data. It is extremely unlikely that a franchisee has been able to cheat the system by under-recording the level of sales revenues, as this is the figure upon which the franchisor's royalty is calculated. And it's even more unlikely that the franchisee would fraudulently overstate the sales revenues thereby exposing themselves to more tax and GST and increased royalty charges. Furthermore, to go undetected the perpetration of such a fraud would have to have started some 12 to 18 months prior to the vendor placing the business on the market for sale.

There is unfortunately always someone trying to beat the system. Most get caught but for those who don't, common sense and a good accountant should be able to identify them! Given reliable sales figures, you don't need a fortuneteller or a crystal ball to be able to predict with a degree of accuracy the future financial success of this business.

Tip No 3: While a good franchise should have good support systems and excellent training, even those franchises that boast incredibly long training periods may only ever deliver little more than well trained franchisees if their business model is flawed.
Of the 350+ franchised systems in NZ, about 40 are food related franchises. Of those 40, some fall well short of any degree of success. There are some pretty ordinary franchisors out there and some pretty extraordinary ones too! How do you tell the difference? The first question you should ask yourself, is would you marry a mail-order bride without first meeting her in person and risk potentially exposing the family fortune to a future matrimonial division? Becoming a franchisee is about entering into a daily working relationship with a franchisor. You have to be able to work together which means showing mutual tolerance and respect for each other. If you don't take the time and trouble to explore that arrangement, to seek the opinions of others both within the franchise and in the franchise community, then beware the consequences of the arranged marriage.

Tip No 4: Ask yourself the question, just how successful is this franchise nationally and internationally? Just because a franchise is successful in another country, does not mean that is will be equally (or at all) successful in New Zealand. Many franchisors have discovered this to their horror and at the financial expense of their unsuspecting franchisees.
If it is a franchised café you are looking for, the big brand names include Columbus Coffee, Esquires, Gloria Jeans, Muffin Break, Robert Harris and Sierra. Other cafes are trying to emerge but are based upon yet-to-be tested fundamentals or proven systems. The Coffee Club, the hugely successful Australian franchise, is the new boy on the block and indications are that astute investors are starting to queue nationally to be a part of this success. So, how do you decide which franchise is for you? That decision is often driven by a combination of factors: the range of business options available within your time frame for buying a business, your preferences as to location, your price range, your perception of the opportunity for capital gain, lifestyle and profitability expectations and your own brand preference.

Franchise restaurants are significantly more popular than franchised cafes, with a prime example being the crème de crème of them all, Subway Sandwiches and Salads. With nearly 24,000 restaurants worldwide in 84 countries; ranked by Entrepreneur magazine as the number one franchise in the world for the 13th time in the last 17 years, and ranked second fastest growing franchise in the world, Subway epitomizes what to look for in a franchise. As with all other successful brands, many others seek to emulate its recipe for success. While some fail, some succeed.

The choice is then between a franchise which is a proven success, usually a premium rising star at a lesser asking price, or a more sophisticated and complex franchised licensed restaurant. Popular big brand names include Cock and Bull, Lone Star, Valentines and in particular Cobb & Co. The same principles apply to these franchises, although the investment level can be larger.

Tip No 5: Location is very important. High foot/drive past traffic translates into high sales.
Unfortunately, landlords in such locations often charge rents which amount to a profit share – often their share being more than yours! All things being unequal, you simply have to be satisfied with your share and not get too immersed in the morality that drives landlords to expect such a high rental return.

This article appears courtesy of The National Bank .

21/08/2007

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