The chicken or the egg?

By franchise advisor David Nelson

How often have I heard that saying?  How can you possibly know which is first?

Study the feasibility or just go for it?

Well, this is a question I do have an answer for.

I know from my experience of advising potential franchisors for a couple of decades that when deciding what comes first, just going for it and selling and rolling out a new franchise, or getting the financial projections and assumptions correct first so you know how feasible it is, that it should always be the latter that comes first, no question.

I have been approached, both recently and numerous times over the many years I have spent providing advice, by new or potential franchisors, who already apparently know how much their franchise will sell for and how much royalty they will charge, and that they are going to make a fortune.  My first question will always be - can I see the profit and loss and cash flow forecast for years one, two, and three for the franchisee and the same for the franchisor? 

Sometimes, I am pleasantly surprised, and these documents have been created and used to calculate the correct initial investment fee to be charged to a potential franchisee and the ongoing royalty rates.  Often, unfortunately, only the simplest of figures have been produced and are not reliable or accurate enough upon which to base these complex calculations.

Frequently, instead of looking inwardly in detail at the numbers from the franchise pilot, and let’s not even discuss here those occasions where franchises are started with no proven pilot, that is for a whole other article, the initial investment fee and royalty have been based on looking at other franchise models on the market and saying, well if that can be sold for £x, then I will charge £x as well.  Not a particularly scientific approach and one that will easily be a problem with any sophisticated franchise buyer who looks to carry out the correct due diligence.

For a franchise operation to be ethical and to be successful in the short, medium, and long term, there must be a mutually beneficial, financial foundation upon which to build. If this foundation is not equitable on day one it will not become more so as time goes on, just the opposite, it will be the source of many cracks that appear as the franchise is attempted to be built.

The only way to truly know that the financial foundation is sound is to forensically assess the financial results of the pilot business, making allowances for the fact a new franchisee will have the benefit of support, guidance, and the hard-earned hindsight from the franchisor. But, also allowing for the reduction in profit margin the introduction of the extra overhead a royalty payment will create. Once this is done, then these values must be weighed against the other investment options available to a potential franchisee in the marketplace, not just like for like but also including other opportunities they may consider. Having assessed this correctly and allowing for the immaturity of the franchise, an initial investment fee can be calculated as the correct market value for the franchise. All of this needs to be done alongside a review of the current market, the strength of brand, and the effects of geographic variations.

However, this is not the end of the process - once a reliable set of financials have been produced for the franchisee model that passes the above tests, then these need to be used to feed into a similarly detailed set of forecasts for the franchisor. Allowing for not just the expected setup and infrastructure costs, but also the costs of marketing, recruitment, and most importantly and often underestimated, the support time that is necessary for new franchisees. Then the calculation can be carried out to see, based on a reasonable and possibly stress-tested number of franchise sales and the accompanying royalty income, that the project numbers add up and will not have cashflow issues along the way.

I have dealt with projects that once the financial feasibility has been carried out in this manner; the initial thoughts have had to be totally rethought saving costly mistakes.   I have also seen other projects launched by franchisors who have not carried out this process - most have either failed or hit some very hard times along the way and have had to make changes that in the franchise model could have been foreseen and avoided.

To summarise, always spend plenty of time carrying out a detailed feasibility study first, of the market potential and the financials, before just going for it.  Yes, it will mean more cost and time initially, but it will save a great deal of time and money in the medium term.

If you have growth aspirations for your business and think franchising could be the right route for you, please get in touch for a no-obligation chat. We can help you from day one to assess and set up your franchise business the right way and avoid the pitfalls.

Call the franchise team 01772 367 367 or email us info@thebusinessclinic.org