Can I Franchise my Business? - Financial Considerations

In Part 1 of our series "Can I Franchise my Business?" I covered crucial factors such as branding, consistent business systems and maintaining uniformity.

In addition to these foundational elements,  in my experience, when considering whether franchising is the right growth option for your business, it's essential to ensure the financials make sense; you need to know that there are opportunities for growth and profitability.

One important factor to consider is the market for your product or service. Is it currently in demand, or is it in a saturated market? Will the need for it be sustainable in the long run? Another consideration is whether a franchise can generate a profitable business venture both for you, as the potential franchisor, and your potential franchisees. 

The profitability of the franchise depends on factors such as franchise fees, royalties and other operating costs.

Ultimately, before deciding to franchise your business, it's vital to conduct thorough market research and analysis to ensure you make an informed decision.

Analyse your business model

What is the Market for your Product or Service?

Is the Market for your Product or Service Sustainable?

Do the $ Work?

1 - Analyse your Business Model

Analysing your business's strengths and weaknesses is always an important step in determining the next move for growth.

What aspects of your business model are working well and what could use improvement? Are there obstacles within the current structure that might hinder success when replicating your brand through franchising?

Understanding these strengths and weaknesses can help guide you towards your decision to franchise your business or explore other growth opportunities, such as organic growth or licensing. 

In the strengths section illustrated below, I have included a "reputable brand" and "streamlined processes", being two of the foundational elements that I discussed in the first article in this series.

In the weaknesses section illustrated below, I have included "ineffective marketing strategies".

Ineffective marketing strategies have significant impact in a franchise network, both in terms of the inability of those marketing strategies to generate customers and additionally, the friction arising from a franchisee's advertising levy being used to fund an ineffective campaign. One of the most common complaints that I hear from franchisees whose businesses are underperforming is that the advertising conducted by the franchisor was ineffective.

In the opportunities section illustrated below, I have included "new customer segments, or untapped markets", two opportunities that franchising as a growth strategy can assist with.

2 - What is the Market for your Product or Service?

As in the case of any business, it is important to conduct thorough market research to assess the potential for success in the desired location.

When giving advice to prospective franchisees looking to purchase a franchise, I usually discuss the market for the product or service that the franchise is offering. Is there a market for those products or services in the location where the franchisee wants to operate?

Analysing the market involves analysing factors such as the local economy, competition, demographics, and consumer behaviours.

Consider who your current customers are and why they buy from you. If possible, segment your customers into different demographics. Look at age, gender, income and occupation.

Also consider the competitors in your proposed market. Who are their current customers? If you franchise your business, will you be targeting the same market as your competitors? If you will be targeting the same market as your competitors, is there enough demand to support additional outlets of your product or service?

Once you have analysed your customers and your competitors, consider your Unique Selling Proposition (USP). Your USP is your point of difference. Knowing and marketing your USP is important to not only attract customers to your brand, but also to attract franchisees.

Ideally, your USP should solve a problem for your customers.

Broadening your market requires careful consideration, but it can lead to significant growth opportunities for your business.

3 - Is the Market for your Product or Service Sustainable?

There is no guarantee that the initial demand for a product or a brand will be sustained. The life cycles of products and services may be shortened by technological advances, new competitors may enter the market or the popularity of your product or service may quickly wane.

When considering the sustainability of the market for your product or service, it is essential to delve deeper into your target market and thoroughly evaluate your USP. Understanding your target market's needs, preferences, and behaviours will help you assess the long-term viability of your business.

By conducting market research and analysing your target market, you can gain valuable insights into purchasing habits and determine if there is a sustainable demand for your product or service. Additionally, understanding your USP and how it solves a problem for your customers will help you gauge the market's sustainability.

However, it is important to note that sustainability is not solely dependent on your target market. Economic factors, such as the local economy and competition, play significant roles as well. Analysing these factors will provide you with a comprehensive understanding of the market's sustainability.

Lastly, environmental and social factors can also influence market sustainability. 

4 - Do the $ work?

When assessing whether you can franchise your business, it is critical to ensure that the franchise system will be financially beneficial for both you as the franchisor and also for your potential franchisees. 

Franchise fees, royalties, and other operating costs should be carefully analysed. It is important to strike a balance between profitability for you as the franchisor and a reasonable return on investment for the franchisees.

Conducting thorough financial modeling and working closely with your accountant or business adviser can help you determine if the financials make sense for both parties involved.

Franchisee Return

To get a basic idea of whether your business could work as a franchise outlet, it is essential to prepare a financial model based on the profit and loss statement for your existing business. This profit and loss statement will serve as a foundation for evaluating the potential success of a franchisee outlet.

Once you have a clear understanding of your current business's performance, you can start incorporating the financial aspects of a franchise model.

Begin by including royalties, which are ongoing fees paid by franchisees to the franchisor for the use of the brand and intellectual property. You can initially calculate these royalties based on industry standards. Royalties can either be a percentage or a fixed fee.

A consultant that I have worked with closely over the years has repeatedly commented that if you remove the royalties from the financials of a failing franchise business, the business will often be profitable. Consequently, you need to ensure that your current business makes enough profit to sustain the royalties that you want to charge. 

Next, include advertising fees (note: not all franchisors charge an advertising fee). These are ongoing fees paid by franchisees to the franchisor for group advertising and related expenses. If the franchisee is going to pay an advertising fee, it is important to remove from the financial model any advertising costs incurred by the business in its current form. 

Additionally, identify any other regular fees that may be included in the franchise model. These could include training fees, technology fees, or support fees. Include these fees in the financial model and evaluate the necessity and potential impact of these fees on both you as the franchisor and franchisees.

(Tip: use the Franchise Disclosure Register as a resource to see what fees other franchisors are charging for similar franchise opportunities).

As you incorporate these financial aspects into your financial model, ensure that they align with your overall business goals and objectives. The financial viability of the franchise should be carefully considered to ensure a mutually beneficial partnership between you as the franchisor and potential franchisees.

To enhance the credibility of your financial modelling, I recommend that you get advice from professionals such as accountants or business advisers. They can provide valuable insights and expertise to help you accurately assess the potential profitability of franchising your business.

Franchisor Return

In addition to forecasting whether the current business can work as a franchise outlet, it is crucial to prepare a projected profit and loss statement for your franchisor business. 

When preparing the profit and loss statement, it is important to consider all sources of revenue for the franchisor.

These include:

• upfront franchise fees, which are the initial fees paid by franchisees to join the franchise system. These fees should be carefully calculated to ensure they cover any initial investments;
• ongoing franchise royalties, which I have covered in the previous section; 
• advertising fees which are paid by franchisees to the franchisor for group advertising and related expenses. These fees must be deposited to a separate marketing fund, which should operate in accordance with the Franchising Code of Conduct. As the franchisor, it is your responsibility to contribute to the marketing fund at the same rate as each of your franchisees if you continue to operate your business.

At this stage, you should also consider how you think that you will deal with any rebates that you receive from suppliers. When I first became involved in franchising in the 1990's, franchisors often passed on rebates to franchisees. The benefits of greater buying power was at that time viewed as one of the benefits of buying a franchise.

Fast forward to the 2020's and rebates are often retained by the franchisor. In larger systems rebates are substantial.

Remember, you can retain some rebates and pass other rebates on to your franchisees. There is no one size fits all model.

Again, to accurately forecast the financials of your franchisor business, I recommend that you work closely with your accountant or business advisor. 

Key Takeaways

Franchising can be a valuable tool for business owners to expand their reach, but there are key components that you should consider before making the move.

The key questions that I have set out in this article are:

What is the market for my product or service?

Is the market for my product or service sustainable?

Do the $ Work?

By taking the necessary steps, such as analysing your current business model, understanding your financials, conducting market research and understanding associated franchise fees you can more easily decide whether or not franchising is right for you.

Also keep in mind that any questions you may have during the process should always be addressed and answered thoroughly by professionals that have experience in franchising so that you feel confident in making an informed decision.

Disclaimer

The information in this article is general in nature and is not intended to address the circumstances of any person or other entity. Although we do our best to provide timely and accurate information, we do not guarantee that the information in this article is accurate or that it will continue to be accurate in the future.