Top tips from industry expert Len Rainford
In the UK, there’s no legal requirement for a disclosure document, but it’s considered good practice to voluntarily disclose relevant information about a franchise and the people involved in it.
The first questions most prospective franchisees ask when considering a particular franchise relate to their financial investment and how much money they can reasonably expect to take home as the business grows over time.
This is understandable. It’s a business after all and all businesses have an element of risk. As any franchise is an investment, prospective franchisees are right to focus on the monetary side of the venture.
However, since it’s a business that involves a long and close relationship with a franchisor, it’s critical for prospective franchisees to undertake an in-depth review of the qualitative aspects of the franchise offering as well.
It’s crucial to have confidence in the value of being affiliated with their chosen franchisor, as the franchisor/franchisee relationship is a major key to success. This is because what you’re investing in when buying a franchise is the right to benefit from the franchisor’s brand, experience, systems and reputation in the marketplace.
A prospective franchisee should focus on such things as the strength of the brand and it’s success in its sector. Has it a proven track record? How long has it been operating? How big is the network? Is there a training programme and ongoing support? How experienced is the franchisor and its staff and what makes the franchise stand out from the competition?
By obtaining such information, prospective franchisees can evaluate the various opportunities and make better judgements.
Financial due diligence
Prospective franchisees need to analyse the franchisor’s initial investment estimates and ongoing royalty and marketing fees in relation to the levels of revenue they can reasonably expect to generate as their business grows.
They should receive financial projections, including profit and loss and cash flow forecasts.
When can you reasonably expect to break even? Can you afford to pay employees and still take home a reasonable income? If not, do you have the reserves to weather the start-up phase of your new business?
As a word of caution, bear in mind it’s estimated that in a third of all cases the financial projections can be overstated.
The length of the initial term, renewal terms, transfer rights and termination rights need also to be considered. Is there a renewal fee or any other ongoing or extraordinary fees imposed under the franchise agreement?
An assessment of the franchisor’s financial stability should be undertaken to ensure it has the funding to support the franchise network. You can do this by asking your accountant to review the franchisor’s accounts or by obtaining a status enquiry through your bank or Companies House.
The financial information, particularly the forecasts, will help you assess the performance of the franchise and make informed decisions.
As the majority of franchisees will need to raise working capital, a good franchisor will be able to give you financial summaries that present the figures in a way that’s clear and concise to smooth the process of accessing finance.
Sources of information
A franchisor should be able to answer all the basic questions about its systems and finances. If it can’t or seems reluctant to do so, steer clear.
One of the best ways to carry out due diligence on a franchise is to talk to existing or former franchisees. It’s important to speak to several, as they will be able to give you candid assessments and opinions on all aspects of the business.
This is not as easy with a new franchise, particularly if you are the first franchisee. However, you must be satisfied the franchise has run a successful pilot operation and has used people with a proven track record in the industry.
Finally, it’s advisable to seek appropriate professional assistance. Additional information can be found through third party resources such as the British Franchise Association, franchise forums, franchise consultants and experienced solicitors affiliated to the bfa.
About the author
Len Rainford runs The Franchise Specialist and is a special adviser to the Business for Breakfast franchise. He works with the owners of Business for Breakfast to enhance the already strong franchisee/franchisor relationship and ensure both existing and new franchise relationships grow and develop across the UK and internationally.