Don’t Over Pay for a Franchise
Doing a comprehensive job of homework is the key to success in buying a franchise. Leave the emotions at home – the fact that you’re out of a job and need to find something in a hurry; you’ve found the ideal location either just around the corner from your home or down at your favourite coastal region; or you just love a certain type of food.
None of that counts. No, it’s the hard business facts that alone should dictate your decision, and top of that list is affordability. The franchise investment will consist of set-up cost, working capital and initial franchise fees. It is wise to make sure that you don’t invest your entire life savings, but that you have some sort of buffer available in case things go wrong. Commercial banks usually require a 50% cash contribution on the entire investment from the franchisee before considering the granting of finance.
What fees might you expect?
The Franchise Association of South Africa (FASA)’s recently published its annual survey which, among other information, gives the ballpark costs of franchises – and the other fees.
There are four sets of costs:
- The franchise fee – in the language of franchising, ‘franchise fee’ is the initial cheque you write to the franchisor when signing up, and is usually a flat fee.
- Management services or royalty fee – the principal fee in franchising after the franchise fee, is the royalty fee payable to the franchisor throughout the term of the agreement. This is the cost of staying in the system, is typically a percentage of your sales, and is for the use of the franchisor’s intellectual property.
- Marketing and advertising levies – this depends on the terms of the agreement. It is for marketing and advertising to develop the franchisor’s brand (and therefore yours, as the franchisee benefits from this brand equity).
- Working capital – this is the capital of a business used in its day-to-day trading operations, calculated as the current assets minus the current liabilities. This is not the franchisor’s money, but rather yours, but the quantum may be dictated by the franchise agreement to ensure the business is viable.
What are the average costs?
The FASA survey lists them as follows:
- For the upfront franchise fee, the average amount is R248,000, with the amounts ranging from R530,000 for a fast food or restaurant outlet to R43,000 for a construction outlet.
- The average management services fee was calculated at 5,7% of turnover. This figure rises to 10,8% in the health, beauty and body culture business and drops to 3,6% in the construction sector.
- Marketing and advertising levies would cost a franchisee, on average, 2,3% of turnover, with the figure rising to 3,8% in the real estate sector and dropping to 1,1% in the health, beauty and body culture sector.
- The average amount of working capital required when buying a franchise is estimated to be R634,000. This amount rises well above the average for a retailing business (R961,000), a fast food or restaurant (R839,000) and an automotive business (R823,000).
A resale business
Buying a resale franchise business requires additional research. Realise right from the outset that you should be dealing as much with the franchisor as the current franchisee when doing your research and negotiating the deal. Find out as much as you can when investigating the franchise resale to ensure that you don’t overpay as well ensuring that you understand the legal and compliance status of the business.
The first place to start is to understand why the franchise is up for sale.
Then, take the time to work with an accountant to review the company’s audited financial records, including:
- Cash flow statements
- Balance sheets
- Accounts payable
- Accounts receivable
Also, go through the staff records to understand wages, sick leave trends and benefits. Unclaimed leave will be a liability you’ll inherit if you purchase the business. It’s also vital to understand the major contracts that the company has with any clients or suppliers, as well as any current legal issues.
Of course, the most important of all relationships and agreements will be those with the franchisor. So knock on his door too. Also, speak to other franchisees in the system to understand the level of support provided by the franchisor.