As a new franchise owner, your success will not only hinge on making clever decisions, but also on avoiding mistakes. While you should be confident about starting your franchise venture, you shouldn’t let it blind you to realities of business. Navigating the financial aspects of franchising can be challenging and common mistakes can range from lapses in judgment to serious miscalculations.
The most common causes of franchise failure are: lack of funds, poor people skills, reluctance to follow the formula, a mismatch between the franchisee and the business, and poor management.
Of these, insufficient funding is a prescription for failure in any business. Although the initial fee is clearly stated when buying a franchise, newcomers often underestimate operating costs. A slow beginning or unforeseen event can quickly drain your resources and doom you to failure.
Therefore, you need a financial cushion to help you weather unexpected challenges. All new franchisees are advised to have a contingency fund for emergencies, as they can assume that they will lose money for the first two years.
Here are some common financial mistakes made in the early stages of buying and operating a franchise business:
- Failing to understand the legal and financial obligations contained in the franchise disclosure document (FDD), the franchise agreement, any accompanying development agreements, as well as related franchise contracts. It is a good idea to invest some money in obtaining advice from legal and financial advisers with experience in franchising, to help you understand the legal and financial obligations of the franchise relationship.
- Underestimating the start-up costs of a franchise business. It is important to have a good understanding of all the costs that will be incurred so that you can arrange for appropriate levels and sources of financing.
- Miscalculating the level of working capital needed for the business, particularly in the start-up phase. It is critical not to run out of working capital while establishing the business.
- Not understanding how the royalties, advertising funds and other required payments will be calculated and collected by the franchisor. These represent significant costs for a franchise business and must be budgeted for in your business plan.
- Leveraging the business so that the debt level is greater than the equity. Having a proper capital structure in place is important to ensure an appropriate level of equity capital, as well as sufficient cash flow to satisfy all debt and other obligations.
- Not planning properly for future capital needs, including renovations, refurbishment, and new equipment, etc. to comply with the franchisor’s requirements and keep the business up-to-date. It is important to set aside a reserve fund for these requirements.
- Undervaluing your personal liability as the owner. It is common for the franchise owner to be required to personally guarantee all kinds of obligations for the business, and it is therefore vital to understand the exact nature of personal liabilities.
- Not properly documenting partnerships or similar relationships. It is important to provide for voting, buy-sell and related issues when you start out in the business to avoid costly disputes later on.
- Misjudging the time commitment required to making the business successful, especially in the first year. Starting a franchise business will take a huge commitment of your time and energy.
- Viewing the franchise as a short-term business option. Most franchise agreements are for a minimum of 10 to 20 years and if you decide to sell, a new owner will have to be approved by the franchisor. It is, therefore important to understand the long-term nature of franchise relationships and to plan accordingly.
MORE COMMON FINANCIAL MISTAKES
New franchisees can learn from their peers on how to best avoid common mistakes. By knowing in advance what the challenges are, you can shorten the learning curve and protect your financial resources.
Entrepreneurs tend to be overly optimistic about their businesses. They often believe they will achieve positive cash flow within a year, or do their marketing online at no cost, and that their product development will be flawless, etc. However, business seldom goes according to plan. Many business owners discover that it takes at least a year longer to grow their company to profitability than they originally anticipated. In the meantime, they are using their initial investment funds, which will quickly run out.
To avoid this, be conservative in your forward projections and have a mentor look at your plan and give an honest evaluation. You’ll probably find that you will need twice as much funds as you initially thought you’d need.
Poor accounting practices
It can be easy to lose track of where your business’ finances are. Simply monitoring cash in the bank is not enough. A lack of financial reports will mean you have no insight into any financial trends, which minimises your ability to be proactive and make prudent financial decisions.
Having comprehensive financial reports will allow you to track performance, monitor cash flow, and help with forward projections.
Entering into long-term financial commitments too early
When you receive your initial funding, having a lump sum of money can give you a false sense of security. Hiring employees, renting bigger office space, signing up for insurance policies, and leasing equipment often make your money disappear quite quickly
Once you have signed long-term commitments they are difficult to get out of. Rather be as conservative as possible with spending and only when your company begins to experience growing pains (under- staffed, cramped quarters, can’t fill orders fast enough, etc.), should you consider spending.
Allocation of resources
When evaluating what to spend your capital on, weigh the cost-benefit of each option. By prudently allocating the resources you have, you will prevent over-spending. Weighing the advantages and disadvantages of a specific expenditure will help determine what you can live without, or find a more cost-effective alternative elsewhere.
Lack of forecasting and budgeting
Having a comprehensive business plan is essential to the success of your business. A sales forecast and expense budget will help guide your business decisions. Without a roadmap like this, you’ll never know whether you are on track with your business. You must, therefore, develop even a simple forecast and budget so you can benchmark your performance.
By implementing practices to avoid these common mistakes, you’ll save yourself a lot of time and resources, which will enable you to focus on growing your business instead. Your time as a new franchise owner will be best spent being proactive, not reactive.