Franchise : Warning flags to look out in franchising

Entrepreneurs are acknowledged for their creativity and consideration of many business expansion options.

Often the decision to franchise can be taken too early for reasons unrelated to the desire to expand, e.g. obtaining finance to cover operating costs.

This means the entrepreneur fronts franchising, prepares all packages to raise capital, approaches and secures financing from various financing options only to use the funds to cover operating expenses of the existing outfit.

By the time financiers wake up, the business is deeper into financial limbo.

It gets worse when the decision to franchise is based on obtaining finance to recoup losses.

While franchising would offer a long-term solution to this, it is dangerous to attempt franchising a loss-making business because there are minimum disclosures required before franchising and unless deceitful, it is unlikely that anyone would engage in a loss-making franchisor.

Four warning flags to look out for when deciding to franchise are;

First, a concept/ idea only cannot be franchised. Many entrepreneurs have grand business ideas which they are passionate of and would like to implement. Many concepts, even from the best of entrepreneurs, are known to fail when they hit the market. The very nature of franchising requires a business wishing to franchise to have already been tried, tested and trusted.

Second, a business without a clear potential for growth cannot be franchised. A business may have ran for at least three years and may even have the recommended minimum number of outlets but may not have a clear growth potential due to various factors. Some may include being in a declining industry, having started based on owner’s capricious, emotional and impulsive approach, poor management and changing consumer demands. Professionally, a prospective franchisor issues a Franchise Disclosure Document in which it presents its history and growth outlook. Franchisees risk their money and energy when engaging with a franchisor and before doing so they have to ensure the franchisor’s business growth potential will help them achieve their own growth goals.

Third, a business that currently does not achieve a reasonable return on investment (ROI) cannot be franchised. ROI is a performance measure used to evaluate efficiency of an investment or to compare efficiency of a number of different investments. Expressed as a percentage or a ratio, it is calculated by dividing the benefit (return) from an investment by the cost of the investment. If an investment does not have a positive ROI or if there are other opportunities with a higher ROI, then the investment should be dropped. Franchising is about wealth creation and a good current ROI is a good indicator of the business’s potential. What a good ROI is will vary between industries but a constantly positive ROI is a good indicator.

Fourth, the business has a limited operating history. Rule of thumb: a prospective franchise should have at least two to three successive years of profitable trading and at least two to three own outlets. Experience gained through this initial operation is encapsulated into a business model through systems, structures and a culture that can be replicated anywhere.

It is this value that the franchisor grants the franchisees, who then use their resources and energy to build the brand further and deliver the brand’s promise.