Does a higher investment level mean higher potential profits?

John Pratt writes:

It should do. Clearly, there’s no point in a franchisee investing considerable sums of money in a business that’s unlikely to provide adequate returns.

Most franchise agreements last for five years, although five-year agreements should be renewable at least twice by a franchisee. As a rough rule of thumb, a franchisee’s business will be loss making in the first one or two years, will break even in years two or three and make a profit in years three, four and five.

The amount of profit that it’s likely a franchisee will earn during that initial term should be enough to reimburse the franchisee for all the initial costs in taking the franchise, including working capital requirements. In franchises that involve substantial expenditure, you would certainly expect a much longer term than five years and substantial levels of profit.

What this means is that the initial costs incurred by a franchisee do need to be linked not only to the term of the franchise, but also to the level of profit that could be earned. It’s for this reason that prospective franchisees will almost always want their franchisor to provide them with projections for at least the first two or three years of their franchise operation - for much longer it becomes a bit more of a guess.

John Pratt is senior partner at specialist franchise firm Hamilton Pratt and has advised franchisors for over 25 years.