Inspired Business Solutions advise on buying a franchise from a finance point of view
Wanting to buy a franchise is a good aspiration. As a rule, franchises should be easier to operate than a standard business, as a great deal of thought has gone into developing the business model, the systems, and in most cases, the marketing and unique point of difference that will hopefully give your franchise business an edge.
Failing to Plan is Planning to Fail
However, when buying a franchise Inspired Business Solutions encourage clients to do some personal and business planning. In most cases, a business is a reflection of the owner or founder. So part of your personal due diligence is to look at your prospective franchise and talk to the Franchisor to satisfy yourself that the business fits your personal mission and values.
Our view is that business is not an end in itself, but a means to an end. To put it another way, you need to be clear about what you want out of life in all its different aspects and in the light of the different roles you may play, such as parent, child, worker, sports coach, and community member.
We have seen many business owners become increasingly frustrated with their businesses. Sometimes it was because they wanted more income than their business could realistically produce. In other cases, they wanted more discretionary time, but found the business consuming their lives.
So our first principle for those wishing to buy a franchise would be to do some thorough personal planning and be very clear about what you want.
Do Your Homework
The second principle is to do your homework (often referred to as “due diligence”). You need to be very clear about what you are actually paying for, what the franchisor is providing you, what your responsibilities are, and so on.
The first piece of advice would be to check that your franchisor is ideally a member of the Franchise Association of NZ. Members are obliged to abide by a Code of Conduct, which includes among other things, providing prospective franchisees with a seven day “cooling off” period after signing.
Much has been written on the importance of due diligence, and the sorts of questions you should ask a franchisor, so we don’t feel it necessary to reinvent the wheel here (for example, if you haven’t already, you should review Lorraine Lord’s article titled “200 Questions to ask Your Franchisor”, which is available on the Franchise NZ website and was most recently included in Vol 16, No 2 of the magazine.) The more questions you ask, the more likely you are to discover how good your franchise really is.
Good franchisors (with established franchises)will often and should let you talk with other franchisees who have owned their businesses for some time, and can tell you what things are like, and how they are doing.
You should also give serious thought to your personal and business structures. If you have already built up a solid financial base, and are planning to buy a franchise later in life, you should consider the possible benefits of protecting your personal and investment assets from unnecessary exposure to business risk by establishing a family trust.
You also need to think about the type of business structure you may need for operating your business. If you have a small franchise, you may find that operating as a sole trader is the best decision from a cost-benefit perspective.
For bigger franchises, you may be obliged under the terms of the agreement to establish a limited liability company with a certain minimum level of capital invested. Other franchisors may give you some flexibility around business structures.
You may find that a trading trust is an ideal structure. Providing you have good advisers, trading trusts are sometimes easier to manage, have lower levels of reporting requirements, and are easier to wind up than companies.
For example, companies are required to comply with the Companies Act 1993 and the Financial Reporting Act 1993 when it comes to financial reporting and governance requirements. If your business is operated through a trading trust, these requirements are less relevant.
When you are considering business structures you should seek advice from professional advisers who are also members of the Franchise Association of NZ. Not only will you ensure that these advisers understand the issues around franchising, but they will ensure you get the best advice for your own unique circumstances.
Show me the Money
Sooner or later, you will need to write out a cheque and commit your financial resources to buying your franchise. Before you part with any money, you should make sure you are clear about the level of investment you need to make in your franchise (both initially and on an ongoing basis) and how you will earn a return on that investment.
Part of the return on investment question goes back to the personal planning issues we raised earlier. You should specify how much you want from the business by way of a salary as a working owner, and also how much you want as a return on the money you have invested in the business.
If you can’t do better owning a franchise than you could by investing the same amount of money in the bank, you should probably reconsider your decision to buy that franchise, unless there are other lifestyle or non-financial drivers behind your decision to buy.
You will not know how the business is likely to perform financially unless you do some more homework, in the form of preparing budgets and cashflow forecasts. You will usually be required to prepare these things to support some borrowing from your financier.
If you have insufficient resources of your own to buy your franchise, you will need to talk to a bank or other lender. At the risk of sounding like a broken record, there are franchise specialists in all the major banks, who know how to help you better - these banks are members of the Franchise Association of NZ as well.
To help secure your borrowing, you may need to prepare a monthly budget or cashflow over a period of time, from one to two years (maybe longer in some cases). Whilst you will need to make some assumptions on how the business may grow or perform, the exercise is certainly a valuable one.
Some business owners consider budgets and cashflow forecasts to be documents that accountants prepare, which are then filed in the bottom draw of an office cabinet. Nothing could be further from the truth.
A good budget or cashflow forecast should be considered like a map or navigation plan. If prepared properly, a good budget can be used on a monthly basis to help to see if you are on track or not.
In some cases, we have worked on budgets and cashflow forecasts with potential franchisees, who were surprised to discover all the costs that were associated not only with the franchise, but also with running a business. This information can also be used to help you determine the level of sales you need to make each week and month to ensure you at least cover all your costs.
Knowing Your Numbers
The previous point leads us to another critical point in the decision to buy a franchise (or any asset for that matter). It is vital that you know enough about finances and accounting to be sure that your prospective franchise will work for you.
While you don’t need to be an expert in finances to own and operate a good business, you do need to know key concepts such as the difference between profits and cashflow, break-even points, the relationship between mark-up and gross profit, and how to read a profit and loss statement and a balance sheet.
A good chartered accountant should be able to help you grasp these vital concepts. In some cases you may decide that providing your senior staff with a greater grasp of financial concepts could be of benefit to the business as well.
You will need some idea of how to “keep the score” for your business. Some franchises provide franchisees with accounting systems or with a centralised and outsourced accounting option. Again, you should speak to your Chartered Accountant about the relative merits of the franchise solution if it exists, or about the different accounting packages if you have to do it yourself.
Care should be taken in setting up your accounting system. As chartered accountants, we have seen the electronic equivalents of the old shoeboxes full of receipts. Instead of making our job easier, the electronic shoebox is probably worse, and doesn’t help reduce the cost of compliance.
In addition, thought needs to be given to the issue of internal control. A good “score keeping system” should include sufficient internal controls to alert you to the possibility of fraud or theft, which may happen more during harder economic times.
One interesting aspect around keeping score can be illustrated by making the point that you can’t play tennis with your eyes on the scoreboard. Although the scoreboard tells you if you are winning, the game is played by keeping your eyes on the ball.
Part of your score keeping system should include the measurement and analysis of information that is not just financial. For example, a useful method of analysing and reporting your sales information is to break sales down into its core components, which are:
- The number of clients or customers
- Their transaction frequency
- The average spend each time they transact with you
Most businesses are very focused on increasing the number of clients or customers through their marketing and sales efforts. In fact, research shows that businesses spend six times more on attracting customers than they do on retaining them. Yet a 5% increase in customer retention can result in an increase in profits of 25% to 125%.
Other good non-financial information you should be gathering should include:
- Finding out where new customers come from (you may be surprised, and it will help you channel your marketing dollars in the best direction)
- Conversion rates (for example, you should look at measuring the number of telephone enquiries that you convert into orders – if you don’t know what it is, how can you improve it?)
Buying a franchise should be a decision you make after plenty of thought and planning. Buying a good franchise will not happen by accident. You will need to do plenty of homework, and you should not be hesitant to seek professional advice about the decision.
You will improve your chances of buying and running a good franchise through proper due diligence, careful thought and planning around your business structures, having sufficient financial resources to buy and run the business, and in educating yourself around the numbers side of things.
Knowing your numbers and keeping an accurate score of how you are doing will improve the odds that you get on top and stay on top of your business performance, and ultimately, of the rewards of being in business. All the best, and don’t be afraid to call if you want a no-obligation chat about your next move in franchising.
Craig Weston is a director of Inspired Business Solutions. Inspired Business Solutions are franchise accountants (chartered) and offer financial and accounting services.