Franchises: Aim low for better targets
Monday, March 26, 2007/
There are more than 1000 different franchise chains offering businesses to potential owners throughout Australia, reports ANDREW KENT, but the point to remember is to be selective.
Lesser-known franchises may be a better investment
The micro market for businesses valued at less than $500,000 is the vast majority of Australia’s more than 800,000 business market. It includes sole operators, long-established businesses, existing franchises and new franchises.
Most of these businesses have few tangible assets to speak of because they generally lease their premises and major equipment such as vehicles. So estimated future earnings are a key factor when assessing opportunities in the micro market.
Over the past decade new entrants to the market have been attracted to franchises.
On the surface, franchises present a more attractive bundle of identifiable benefits to the novice purchaser. And with more than 60,000 existing franchise outlets operating in Australia, they represent nearly 10% of Australia’s businesses.
But buying a franchise is by no means foolproof.
There are more than 1000 different franchise chains offering franchise businesses to potential business owners throughout Australia. With many of these chains offering hundreds of franchise licences each, there are potentially several hundred thousand franchise offerings to choose from.
It is important to remember not all of them are going to be viable. Franchising is different from any other business. A franchise agreement is essentially the grant of a licence to operate a franchise unit to the franchisee. The key points of the agreement are:
- Allocation of responsibilities.
- Allocation of costs and revenues.
- Licence term.
- Licence transfer/options.
Allocation of responsibilities
The general principle of a franchise arrangement is that responsibility for the overall operation of the business is shared. Typically the franchisor will be responsible for the majority of brand and marketing activity, while the franchisee will be responsible for the day-to-day service delivery. However, it is never quite that simple and there are often documented procedures, presentation standards, even designated product ingredients and nominated suppliers that must be adhered to.
Allocation of costs and revenues
Just as the franchise shares the responsibility and effort, it also shares the costs and revenue. There are many varying combinations of this, and it is well worth putting them into a spreadsheet to fully understand their implications. This will also assist in comparing the returns of different franchises under different scenarios.
This is one of the key points of a franchise agreement. Typically a franchise agreement will be for five years. There may also be options attached to this. For example, a rolling five-year extension providing certain key performance measures are met, or something similar. If you are looking to purchase an existing franchise outlet be sure to check the remaining term of the lease and clauses relating to the transfer of ownership.
These particular terms are extremely important to the long-term value of your business. If your licence is for a fixed term and you have no control over the extension of the licence, then at the end of your licence term the value of the goodwill created in the franchise where you have been operating may be worth nothing to you.
Some franchisors have clauses in the agreement giving them first right of ownership at the end of a given term.
This enables them to bring selected franchise outlets back under their direct control. This can be a useful means of protecting the overall franchise brand from renegade operators, but it can also be used to bring the more profitable operations into the corporate balance sheet.
Regardless of the intent of these clauses, you need to read them very carefully because this could mean the difference between you buying the rights to rent a business, and buying the rights to own a business.
Once you know what sort of franchise you are looking for then it is worth considering both new and existing franchise opportunities. While new franchises have the appeal of a fresh start, existing franchises have the value of an existing customer base. In either case take a close look at the franchise licence agreement, particularly the remaining term on the licence and any licence extension provisions.
In terms of value for money, you may find that the lesser-known franchises are a better investment.
There are a number of reasons for this. One is that as the franchise industry is better understood, some of the better-known franchise brands have lost credibility in the eyes of consumers. Some have tried to be too much to too many people.
They have been so successful in promoting the ease of becoming a franchisee that this has distracted from the status and perceived competence of the franchisee in the eyes of the consumer.
So some of the franchises that are better recognised as brands rather than franchises may be a better investment over the longer term.
Newer franchisors may try harder and offer franchisees better terms.
Conversly, the more established the franchise is, the more opportunity it has had to bed down its processes and establish its brand. So you will need to weigh up the value and risks of the each opportunity.
Andrew Kent is a director at BizExchange.
BizExchange is an independent marketplace for business for sale or seeking investment.