Guarantees - what do they mean?

With high employment having been a feature of our economy over recent years, franchisors have been looking for new ways to encourage people to become franchisees. One approach that is becoming increasingly widespread is that of offering income or work guarantees.

The idea is that when you buy a franchise, you don’t have to worry about leaving the apparent security of a regular pay cheque because your franchisor has guaranteed that you will earn a minimum amount or receive a minimum value of work to do every month. But does it really work?

The idea of guarantees really originated in the home services industry where new franchisees often start by buying a certain level of work – say $800 per week’s worth of lawnmowing contracts – as part of their franchise package. The franchisor guarantees that, subject to certain conditions, if the franchisee’s level of work falls below a certain level, then the franchisor will provide additional work to make up the difference. The franchisee can then plan accordingly, knowing that they will always have at least $800-worth of work available and therefore $800 of income if they do the work.

Today, guarantees have spread beyond the lower investment home services sector to commercial services, mortgage broking and even, in the case of fashion jewellery franchise Kleins, to retail.

Such a guarantee reduces the apparent risk of buying a franchise. ‘Remember that people who buy franchises are generally seeking the support of a franchisor and access to their brand and systems rather than being prepared to strike out on their own,’ says franchise consultant Grant Garraway who works with Kleins. ‘Such people are generally a little risk averse, so a guarantee is intellectually attractive to them.

‘The concept also appeals to many franchisors. A new franchisor may offer a guarantee to attract potential franchisees who would otherwise be put off an unproven system. An established franchisor might offer a guarantee to attract a wider demographic range of potential franchisees than they were currently reaching. It might also be offered by a franchise suffering from negative perceptions of their brand caused by some previous incident. In other words, the causes might be many and varied but the motive is the same – to attract and reassure potential franchisees.’

What sort of guarantees are offered?

In general, guarantees are divided into two types: work guarantees, where the franchisee is guaranteed a certain value of work that they must go out and do in order to generate income, and income guarantees, where the franchisee is guaranteed a minimum income. Each of these may be further divided by length of term.

Short term

Most common, particularly in the home services area, is the limited short term income guarantee. This is usually for six weeks to six months in order to help new franchisees become established. Should the franchisee not achieve a certain sales figure, the franchisor will ‘top up’ their sales to the guaranteed level. The level guaranteed may vary according to the value of contracts initially purchased from the franchisor.

Mobile services franchises that operate call centres are relatively easily able to allocate new work to a franchisee who needs to achieve a certain level under a guarantee. ‘However, that work may come at the expense of other established franchisees whose guaranteed period has expired,’ comments Grant Garraway. ‘There are also a number of “fine print” clauses in some guarantees that franchisors can cite to avoid paying out (see below).’

First year only

Under this method, the new franchise owner is guaranteed a certain sales or income level during their first year. The franchisor monitors the new franchisee’s sales progress, knows their likely expense levels and calculates the likely profit for the first year regularly during that year. The franchisor then either conducts local marketing to ensure the franchise owner makes the guaranteed income, allocates more work to them from the call centre if the franchise operates that way or, in the worst case, writes a cheque.

‘In some cases, franchisors fund this by adding the expected cost of the guarantee to the cost of the franchise,’ Grant says. ‘If the buyer does well enough not to need all or part of the guarantee, they have effectively paid more than necessary for the business. It does offer some kind of insurance, though.’

Until achieved

This type of guarantee offered by the franchisor remains in place until the franchise owner exceeds a stated sales (not profit) level – however long that takes. As it is open-ended in time, it cannot generally be funded by the franchisor loading the purchase price. The franchisor must believe the income level being guaranteed is genuinely achievable by the right franchise owner within a reasonable period of time or it would cost the franchisor much more than any short-term sales advantage may be worth.

‘Such guarantees are based upon franchisor experience of the market and the ability to accurately predict the likely future performance of a new store or territory,’ Grant says. ‘They will also have done their sums: in some cases, the benefits of having a franchisee invest in and operate a new location will be so much greater than employing a manager for a company operation that it leaves some lee-way to offer a guarantee that attracts the right people. Such guarantees can also be attractive to financing banks.’

What are the drawbacks?

Although guarantees have many attractions for potential franchisees, there can also be drawbacks. The first of these is that, as Grant Garraway has pointed out, they may cause the ingoing franchisee to pay more for their peace of mind than might otherwise be necessary. The second is that the guarantee might not operate in the way the franchisee expects. The third is that the offering of guarantees can distort the market-place and, say critics, actually distract potential franchisees from analysing the true potential of any opportunity.

A recent letter to Franchise New Zealand magazine from a former franchisee detailed his experience of a guarantee that didn’t provide what he expected. In this case, the franchisee bought a service franchise with a work guarantee of $700 per week. When he started he only had $231 of weekly contract work arranged, but the master franchisee for the area was generating new work and he was not concerned.

Unfortunately, just three weeks in the master franchisee was not able to continue and someone else took over who was not able to sell the service as well. The franchisee’s work rose to around $400 per week, which meant that there was little left over after royalties, advertising, petrol and products were paid for. He experienced little support during this time.

After four months, the franchisee asked for the guarantee to be paid out, calculating that he was due some $7000. This was declined by the franchisor as the contract stipulated it would only be paid at the end of the year. Others appeared to be in a similar situation, and noted that the franchise in question was continuing to advertise for new franchisees when there wasn’t enough work available for the existing ones. The franchisor advised that new advertising campaigns were expected to generate more work.

A new commercial contract paying $80 per week was offered to the franchisee. This was for a four hour job on a Saturday morning 20kms from the franchisee’s home and he declined it on the basis that after paying petrol and cleaning costs it would hardly be profitable and would prevent him from taking on better jobs during that time. Declining the work meant that he was in breach of the terms of the guarantee, he discovered. In the end, the franchisee gave up his business. The franchisor declined either to buy it back or pay out on the guarantee. The now ex-franchisee says that, not surprisingly, the experience has put him off all franchise businesses.

Such stories are mercifully rare but they are not unique. According to franchise lawyer Stewart Germann, ‘Over the past five years I have acted for at least three franchisees who have had disputes with their franchisor in relation to income guarantees. In all cases the franchisor has ended up not paying out a cent and has argued that it was the franchisee’s fault. In two of the cases that was untrue, unfair and dishonest of the franchisor but, in one case, I had sympathy for the franchisor. I do not think that any work or income guarantees should be given by a franchisor and I would even go so far as to say they are misleading.’

Do guarantees discourage proper analysis?

In the home services sector, work guarantees are a subject certain to provoke instant debate among franchisors. Estelle Logan, national franchisee for VIP Home Services, sees them as a distraction. ‘People tend to get blinded by the promise of an income guarantee and forget to look at the more important aspects of a franchise system such as training, ongoing support, advertising and marketing. If these are done correctly, they will provide the franchisee with more work than they can handle so there is no need for a long-term income guarantee.’ Nonetheless, VIP offers a work guarantee. Why?

‘It’s something that is expected in the market, and we have to be mindful of that,’ says Estelle. ‘VIP provides an induction guarantee to assist franchisees when they have finished their training and are out on their own for the first eight weeks. It ensures franchisees are receiving a minimum amount of work and that good work habits and ethics are being followed. We do close monitoring and mentoring during this period as we have proved that a franchisee who puts into practice the things they have learned takes ownership of their own business. Once they do that, they have the ability to become successful at whatever level they choose. We have paid out on our guarantee during the induction period but very few of our franchisees have ever had to claim it.’

Richard Smith, at the time of writing the franchisor of Christchurch-based Mr Green, agrees with Estelle 100%. ‘I would actually like to remove the guarantee from our franchise, but unfortunately we need to retain it to remain competitive in recruiting people. We have a minimum guarantee of $600 per week, but it may vary on negotiation. We don’t guarantee income, we guarantee work to that value. Many people we talk to are under the impression other companies are guaranteeing income, and we advise them to check very carefully.

‘I always insist our master franchisees make it very clear to people that the guarantee is a safeguard only and that people actually need to earn to a level that meets or exceeds their personal requirements. We also advise that the guarantee has its exclusions: the weather, acts of God and so on. More important than the guarantee is the company’s philosophy,’ says Richard, himself a former master franchisee. ‘We only sell a new franchise in an area when all incumbent franchisees are working to the level they require.’

A shortage of new potential franchisees owing to the current high employment rate has seen increasing competition among service franchises recently, with some franchises offering still higher levels of work guarantee over longer periods. Estelle Logan feels uneasy about this. ‘The larger the guarantee, usually, the higher the ongoing operating or royalty fee. These ongoing fees have a direct impact on the profitability of your franchise from day one until the day you sell. It might be more reassuring in the short-term but it will cost more in the long-term so it’s something you have to take into account.’

However, Adrian Kenny, founder of @ Your Request, believes the right guarantee is the only way to go in the home service industry. ‘During my 15 years in this industry I have found a lot of people don’t have sales skills but are good in the field. With @ Your Request I developed and refined a guarantee using my knowledge so that it is fair for everyone involved. Of course there are conditions – there have to be. Our brand is based around providing a premium service so that we can get top dollar for our service, and losing a client due to poor workmanship is treated very seriously. If a franchisee does lose work through their workmanship, we immediately put them on to a “best endeavours” guarantee. This means they are still entitled to their $1,000 guaranteed level of weekly clients and the lost customer will be replaced within a reasonable amount of time. They also immediately have to undertake a two day refresher training course to help them perfect their workmanship. We strongly stand by our guarantee, and have paid out on a couple over the years.’

The value of guarantees

If you are looking at buying a franchise, then, what importance should you place on any work or income guarantee offered by the franchisor?
The first thing to be said is that, while a guarantee can be reassuring if you are leaving a regular pay cheque behind for the first time, it is still not the same as being employed. The amount guaranteed is likely to be enough to see you through difficult times or the initial start-up period, but if you do not believe that you will be able to achieve your real goals in this franchise then it is not the one for you.

The second thing is to be certain exactly what the guarantee is offering. Here are some questions that may help:

1. What is the purpose behind the guarantee being offered?
2. Is it a guarantee of work to an agreed value or of income to a set level?
3. What is the guaranteed amount?
4. Under what circumstances will it be paid?
5. How long will it be paid for?
6. What special conditions apply (eg. must I accept any work given anywhere, must I contact the franchise office every day for work?)
7. When is the guaranteed amount payable?
8. What happens if the franchisor cannot afford to pay the guarantee for the specified period?
9. What evidence is there that the guarantee has actually been paid out?
10. If you take the guarantee out of the package, does the franchise still appear to be attractive and viable?

In the future

Grant Garraway believes that we will increasingly see franchises offering guarantees as franchisors get bigger and more confident about their product. ‘In the case of Kleins, they have no problem at all with meeting the income guarantee if the franchisee’s results fall short of the agreed figure, and indeed have done so. The franchisor selects the franchisee and the territory, trains the franchisee, approves or runs the marketing campaigns, writes the manuals, sets out the systems, supports the franchisee and audits the outlet – if a new franchisee follows those systems and works hard, why shouldn’t the franchisor share some of the responsibility and pain if he doesn’t achieve a reasonable level of profit?’

Others, however, say that the concept of guarantees is totally opposed to the fundamental nature of franchising. ‘The franchisee makes an informed decision about the potential of a business opportunity. They are trained, supported, assisted and given every chance to succeed. The level of success they achieve is ultimately up to their own efforts. If you guarantee an income, you take away the element of risk that motivates many people to strive harder and learn the lessons that lead to success. Guarantees may make it easier to recruit, but if someone is relying upon a guarantee to make their purchase decision, they will make a poor franchisee.’

As always, the truth lies somewhere in the middle. Income and work guarantees do have a place in attracting and reassuring new franchisees, but they are only the beginning. True success depends on training, support, commitment and hard work, and no-one can guarantee those.
Franchising is generally a very low-risk way to go into business, but if you want to lower the risk even further, don’t rely on guarantees. Choose wisely, do your research and above all take advice from franchise-experienced professionals. In the end, your success is up to you.

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