Franchisee Tips on Buying a Franchise from the Experts
Franchising is one of the best ways for successful business owners to rapidly expand their enterprises, and especially in South Africa, buying into a franchise is increasingly becoming a source of business opportunities for local entrepreneurs.
Recent statistics released by the Franchise Association of South Africa (FASA) revealed that, in a year of low overall economic growth, the franchising sector’s share of the country’s gross domestic product (GDP) in 2017 was reported as R587-billion – accounting for 13.3 per cent. This is an increase from the 11.6 per cent of GDP recorded in 2016. The number of outlets (franchisees) reportedly increased from 31 111 to 40 528, and the number of franchise groups (franchisors) also grew from 757 to 845 in 2017.
Why franchising?
Jeremy Lang, Regional General Manager at Business Partners Limited, says: “While franchise businesses aren’t entirely immune to the struggles of the economy, the sector’s apparent ability to shrug off the economic malaise can be linked to their ‘tried-and tested’ business approach. The fact that a franchised business has a proven business model, gives it a relative advantage over independent businesses which may still be finding their feet through trial and error.”
Similarly, while an independent business has to double down on marketing to draw in reluctant customers, franchised outlets have the added advantage of brand strength and market acceptance. The continued entry into South Africa of overseas franchise systems looking for global expansion, is also driving the sector’s growth and creating opportunities for local franchisees, says Lang.
“It needs to be said that franchising a business can be a complicated process with its own business risks, if the endeavor is not executed properly. These risks include taking on too much debt for the venture. As the cost of purchasing a franchise can range from a few thousand rands to millions of rands, it is imperative for aspiring franchisees to consider how they will go about financing the business. The outcome of this may influence whether the franchise will be successful or not.”
Secrets to funding
He notes the purchase may be funded through the purchaser’s own capital or contribution (in the form of equity), by borrowing money (debt) or alternatively by a combination of the two – the latter being the most common option.
“Few business owners are able to afford purchasing the franchise solely through debt,” says Lang. “With this in mind, it is imperative for aspiring franchisees to consider the level of equity and debt that is acceptable for their business, as there is no single ratio that would guarantee success. The levels of acceptable ratios between debt and equity can vary from industry to industry, and as such entrepreneurs should understand what the right combination is for the industry in which the franchise will be operating.”
Once this has been ascertained, the entrepreneur should take into account the level of equity they currently have, and combine it with the level of debt that can be realistically raised in order to define whether it will be sufficient to purchase the franchise. “Aspiring franchisees should also note that funding may be required in addition to the setup costs or purchase price of the business in order to cover the working capital requirements and therefore the funding need may be greater than just the purchase price or setup costs.”
Be realistic
Therefore, Lang cautions it is key that a realistic and detailed budget and cash flow forecast be prepared when considering the option of purchasing a franchise, in order to ensure that the business is profitable.
“The value of a franchise is usually determined by the net profit that one can realistically expect to generate from the business. When purchasing an existing franchise, value is more easily determined by using the actual financial results to establish the value. The worth of a new franchise is normally derived by forecasting profitability and cash flow which will require a certain level of assumptions,” he explains.
This can be done by using common valuation methods: The price earnings ratio, industry specific models, discounted cash flow forecasts and net asset value.
