by Philip Morrison
last updated 11/09/2023
People & Profits
by Philip Morrison
last updated 11/09/2023
Philip Morrison suggests financial aspects to look out for when planning on buying a franchise
A few years ago, I attended the annual conference of a well-known franchise which offers lawnmowing, gardening and cleaning services. Part of the event included a celebration recognising franchisees who had owned their business for 10, 15 and even 20 years. The speeches from those operators left an indelible impression on me about the long-term benefits of owning a franchise business.
In my company, Franchise Accountants, we have franchisee clients now clocking up 20 years in a range of businesses: food, lifestyle, retail, commercial services, and more. They are resilient operators, earning stable income, and their business is serving them well. So I asked them what they had learned over the years, why they have continued in the same franchise, and what advice they would give to anyone thinking about buying a franchise right now?
Here's a summary of their answers, which cover both financial and non-financial factors.
Lifecycle of a franchise business
The lifecycle of a franchisee’s business varies by industry, by franchise brand, and by individual owner. Some franchisees are with the brand for over twenty years, while others may on-sell after just three. Changes in personal circumstances, other opportunities, performance or just not enjoying the business can all lead to shorter terms. However, the average tenure is generally around eight years.
Because most franchises are granted for a period of terms, often around 5 years, it means that the long-term franchisees I talked to were forced to evaluate their business periodically and decide whether it still suited them. That’s a process most business owners don’t do, and it’s a valuable one that requires you to ask yourself some hard questions about the return you’re getting for your investment of time and money, the value of the franchise, and how well it suits your family’s needs and lifestyle goals.
When you first look at buying a franchise, a lot of people will start with the questions ‘How much does it cost?’ and ‘How soon will it make me real money?’ Those are vital questions, of course, but if you’re going to be in the business for eight years or more, it pays to look beyond the first couple of years and consider the long-term value of the business.
Typically, any franchise has to evolve and adapt to the market to remain viable in the long term. This would include refining its offering, keeping up with the times to stay relevant, and re-investing in the business systems, branding and people to stay competitive.
So our long-term franchisees felt some good questions to ask are:
- Does this franchise generate a stable pattern of generating recurring income?
- Why do customers buy from it?
- What is the brand’s competitive advantage and is it sustainable?
Established franchise brands can often point to the long-term viability of the network. However, there can be
industry disrupters outside the control of the franchise system. Consider the video rental business: Blockbuster, United Video, Video Ezy were hugely successful brands which have now disappeared as streaming platforms like Netflix, Amazon Prime and Disney emerged. Currently, car dealerships are adapting to massive change with EVs, new brands and direct sales changing the whole business model.
On the other hand, people still enjoy eating out, houses still need cleaning, clothes need washing, packages need delivering and kids need tutoring. By evaluating the industry the franchise operates in, and how well it has adapted to changes in the past, you can assess the long-term viability of the franchise.
One thing I can say for sure about our long-term franchisee clients is that long-term owners operate profitable businesses.
In most cases, they went into business ownership to earn more income than they could in their previous employment. They worked hard over the years and built up a business that generates good income for the owner. In accounting speak, we call this income ‘profit’, and it’s essential for the long-term viability of any business.
Amongst other things, profits fund:
- Returns to owners (income, salaries and dividends);
- Working capital (the pool of money you need to operate a business – buying stock, etc);
- Reinvestment (buying replacement plant and equipment, fitouts and branding updates);
- Reducing debt and building up reserves against the unexpected;
- Research and development.
In any business, how much profit is ‘enough’ will vary according to the owner’s appetite, how hard they are prepared to work, the level of investment, and the type of service or product delivered. In a franchise, many of these factors are relatively predictable. You won’t make as much money as a bitcoin entrepreneur, but you won’t be taking the same risks, either!
Cashflow & working capital
Long-term franchise owners have good financial disciplines in place. Many franchises have good management and benchmarking systems in place, and good franchisees use these wisely.
For example, they put in place a budget so they know where the money goes and how the cash flows through their business. This would include leaving enough money in the business to operate effectively (working capital), setting money aside for tax, and replacing assets as they wear out – only taking out what the business can afford after these things have been allowed for.
For example, if you have a lawn mowing business, you’ll need to replace mowers as they wear out. In the books, that’s allowed for as depreciation. By keeping that depreciation as money in the bank, rather than spending the cash it represents on a jet ski, you’ll have what you need to replace your equipment when the time comes. The jet ski comes from the return to owners.
Long-term franchisees get their money back.
This is often one of the primary financial measures in evaluating any investment decision, including buying a business. Sensible buyers evaluate the ability of a business to repay the initial investment from the earnings of the business after paying the owner a working wage.
Here’s an example. Let’s say the purchase of your chosen franchise requires an investment of $250,000.
The franchise produces an EBITDA figure (that’s Earnings Before Interest costs, Tax, Depreciation and Amortisation) of $50,000 per annum.
INVESTMENT ÷ EBITDA = Payback (years)
$250,000 ÷ $50,000 = 5 years.
In this example, it would take 5 years to repay the initial investment. If tax was factored in, it could extend payback to 7.5 years and depreciation will extend things further. However, it’s more complicated than that, which is why it’s important to take advice from an experienced franchise-specialist accountant.
Return on Investment
This is the flipside to Payback. It measures the return on the initial capital invested.
For example, if you invested $100,000 in a term deposit and it earned 3.5% interest, then the annual return on your investment would be $3,500 (3.5%).
Let’s compare this to investing in a business, using the same example as above:
EBITDA ÷ INVESTMENT x 100 % = Return on Investment (ROI)
$50,000 ÷ $250,000 = 20% ROI
A 20% return is a lot higher than the 3.5% you’d get in the term deposit, but you are taking a greater risk so you would be looking for a higher return.
If you are borrowing some or all of the money to fund your franchise purchase, you also need to allow for cost of finance. If the cost of finance on borrowed money is 8.5% , and the opportunity cost of investing in a term deposit for a guaranteed return is 3.5%, the total cost of finance is 8.5 + 3.5, or 12%. So the real ROI in this example is 20% minus 12%, which is 8%.
Long-term franchisees have generally had greater return on their investment than they would have had from putting their money in the bank, even after allowing for risk and paying additional finance costs.
While people buy a business for many reasons, the long-term franchisees at that conference I mentioned all said that a primary goal in buying the franchise had been to create wealth for themselves and their family.
By paying the business loans off as soon as possible, their cost of finance is reduced and the return on investment improved even further. Although some re-investment in equipment, fit-out or image may be necessary from time to time (see page 58), that makes long-term ownership even more attractive.
Once the business loans are repaid, then it frees up cashflow to pay down the family home loan, or invest in other areas. They used the surplus cashflow of the business to build their wealth base beyond the business itself.
They had recouped the initial investment, and reinvested the profits into building wealth personally, as well as building the enterprise value of the business – in other words, their business would be worth more when they eventually decided to sell. All going well, when they do decide to exit, they can sell the business as a going concern debt-free, and tax-free, too.
It's also worth noting that being part of a known franchise also generally makes a business more attractive to potential purchasers than it would be as a small, stand-alone venture.
Now, you might not expect to hear an accountant say this, but return on investment is not all about money – there are also the intangible measures of wealth, such as happiness, family, lifestyle and security. Being able to pay for family holidays, school fees or contributing where there is need is part of that, but here are some of the other factors that our long-term owners value about their franchises.
If a franchise has a good proportion of franchisees who have stayed within the system for a long time, that’s often an indicator that the franchise has a good, supportive culture.
Of course, there’s always a certain level of franchisee turnover within any established franchise network just from normal life – people looking for a change, facing health challenges or divorce, family circumstances and so on. But if a franchise has a good proportion of long-term happy campers, it’s a good sign.
Peer support and camaraderie
Being in business for yourself can be a pretty lonely experience, which is why one of the biggest advantages long-term franchisees appreciate is belonging to the community within the network. They share their experiences with others working in exactly the same type of business but not in competition with them; instead, they enjoy teamwork and sharing.
For many, this benefit was the most dominant takeaway from the pandemic years – and it encouraged them to stay even longer.
Purpose and meaning
Owning your own business can give some meaning and purpose to your life, as well as the satisfaction of doing a job well. As a long-term franchisee, you gain mastery over the type of business you operate in and have a vault of experience that your clients benefit from. So why do anything else?
In some franchise sectors, the intangible benefits of making a difference in people’s lives are huge. Some obvious examples are tutoring kids in maths and English with after-school programmes; providing transport services for seniors; being a community hub with a popular café; developing skills in sport or the performing arts; helping people feel good about themselves with fitness or beauty treatments … the list goes on.
And don’t forget that franchises are big contributors to charity, both on a local and national basis. Surveys show that 24 percent of franchise brands contribute over $100,000 each to community support.
Lifestyle & family
Last but not least: the single most important factor that encouraged franchisees to stay in their businesses long-term was the flexibility it gave them to enjoy life with their families, to be there for those important life events.
As some said, ‘What else would I do that gave me this freedom to arrange my time in a way that best suits the needs of my family?’
The long game
While the many variables in business mean that no-one can guarantee success, there is no doubt that buying a franchise reduces the risks involved, and that owning a franchised business can provide a long-term opportunity to build a solid business and enjoy doing it.
If the franchise business remains viable in a changing marketplace, generates sustainable profits, and provides adequate return on investment, it can allow a franchisee to earn good income and create wealth for the long-term. Taking advice from specialist franchise advisors can help you evaluate this.
The secret to this success is choosing the right business in the first place: one that can not only provide the returns you seek, but also one that you will enjoy working in – and be proud to share with your family, friends, customers and community.
This article was first published Franchise New Zealand magazine (Year 32 Issue 2).
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