FRANCHISING: SEPARATING FACT FROM FICTION

Separating fact from fiction

It’s the business model that keeps on giving, decades after arriving on these shores. Franchising remains a powerful way to grow a business and a brand. We consulted leading franchise experts for the low-down on an industry that delivers generously for those who come prepared.

It’s the business model that keeps on giving – and trending – decades after arriving on these shores. Franchising is still a powerful way to grow a business and a brand. Nzbusiness consulted leading franchise experts for the low-down on a dynamic industry that delivers generously for those who come prepared.

Franchise businesses are ubiquitous. It may come as no surprise to learn that, per capita, New Zealand is one of the world’s most franchised countries. Those familiar brands dominate our retail precincts and malls, commercial centres and industrial parks the length and breadth of this country, and cover almost every business sector you can think of.

Whether you’re in business already, or looking to get started, franchising has always held a certain attraction: the prospect of healthy profits (albeit through hard work) and that enviable support structure that helps both parties – franchisor and franchisee – reach their goals.

However, as with all prospective business ventures, the old adage ‘buyer beware’ applies. Due diligence is critical, and you can never seek too much expert advice.

New Zealand’s franchise sector is currently more positive about the future than the general business sector, according to the latest quarterly Franchising Confidence Index released in April by Franchize Consultants. And that’s despite the uncertainty over CGT during that survey period.

Simon Lord, editor of Franchise New Zealand magazine and the franchise.co.nz website has worked in franchising for more than 35 years and witnessed its evolution. In 2019, the food and services categories are trending hot, and international interest in the New Zealand market is high, he says, with Australian franchises in particular interested in opportunities here given the current regulatory uncertainty across the ditch.

But there is a niggly issue.

“Basically the biggest problem for franchisors is the same as it has been for five years – a shortage of new franchisees,” he says. “Anyone looking to buy a franchise and willing to look at a new location rather than an established business will be met with open arms in many systems.”

Lord points to a number of factors at play, such as the property market with its historically strong returns; the high employment rate and increased job security. “But another factor is internal competition for new franchisees.”

With around 37,000 franchises nationwide, the sector is vast. Baby boomer franchisees are looking to retire, he explains, and there’s competition between franchisors and franchisees – “franchisors looking to establish new outlets competing with franchisees selling existing outlets”. And new migrants are leaning towards franchise businesses that offer instant cashflow – preferring resale franchises over brand new outlets.

Conversion franchising is an increasingly popular trend in New Zealand too, says Lord. “[This is where] franchisors create a business with certain advantages – such as buying power, proven systems, and a [trusted] brand – but they require franchisees with qualifications or specialist skills to operate in regulated areas. Think out-of-school care, opticians, plumbers, electricians and builders. Specsavers and Laser Electrical are obvious examples.

“They’ll offer these solid, existing independents the chance to join their franchise to benefit from their business model,” he says, adding that low in-goings are a further inducement.

ASK QUESTIONS, MANY QUESTIONS

Just as you would commission a pre-purchase inspection to buy a house or car – the same applies when buying a franchise. Remember, the experts know what to look for – you don’t. They may even have dealt with that particular franchise brand before and have inside knowledge.

On the Franchise New Zealand website Lord lists more than 250 questions for potential franchisees to ask franchisors. “I’m not suggesting for a moment you ask all 250, but it’s a useful guide to the sort of areas buyers need to be thinking about – so you can ask the ones relevant to you,” he says. “A franchisor once told me,'/ ‘when I see someone coming in with your list all marked up in red, I add another hour to the interview. But at least it means they’re serious!’

“Another good source of information about a franchise is the franchisees who are already operating the system, so we’ve got a list of suggested questions to ask them too.”

If a certain franchise appeals to you, remember

franchisors look for certain personal qualities in their franchisees. Selina Hornibrook, chairperson of The Cosmetic Clinic, a New Zealand cosmetic appearance franchise, says they look for people with strong internal drive, who understand the importance of delivering an outstanding customer experience, of creating a positive work environment, understanding basic financial metrics and implementing the franchise system.

One of the biggest stumbling blocks is when a franchisee is not aware of potential franchisor/franchisee conflicts prior to investing in the business, says Hornibrook. “For example, franchisors may worry that if a franchisee doesn’t follow the system the business model may be negatively impacted – whereas a franchisee might feel that having to rigidly follow a system restricts their own innovation and potentially compromises their ability to make a profit.” Another potential conflict is the franchisor’s desire to expand versus the franchisees seeing expansion and increased competition as a threat.

“As part of their due diligence, potential franchisees should ensure that they thoroughly understand what they can and can’t do under the franchise agreement, what territorial rights they have, ensure that they talk to existing franchisees about their experiences, and that they understand what processes are in place for communication and consultation between the franchisor and franchisees.”

Hornibrook’s advice is to speak to a good cross section of franchisees. “Remember you are investing in a franchise because you believe in the system. Therefore, follow the model and leverage the support staff.”

A FINANCIER’S PERSPECTIVE

Like any business, a franchise is expected to grow by the people who invest in them.

Daniel Cloete, Westpac NZ national manager of franchise and strategic partnerships, reports that multi-unit franchises are fast becoming the means to get on a pathway to reinvestment and growth. They can deliver financial strength and a way for existing franchisees to reinvest and grow further. The danger is if franchisees don’t have the management capability to take on more outlets. Financial distress or brand damage can follow. Robust due diligence is vital.

“BASICALLY THE BIGGEST PROBLEM FOR FRANCHISORS IS THE SAME AS IT HAS BEEN FOR FIVE YEARS – A SHORTAGE OF NEW FRANCHISEES.”

– SIMON LORD.

“When looking at funding [for a franchise] talk to a specialist franchise banker who understands the model and knows the transactional requirements of the system,” advises Cloete. “You’ll also need ongoing support after buying the business.” He says in a franchise system he looks for:

• A proven product or service.

• A strong brand or accepted trade name.

• A tried, tested and documented way of doing business.

• Good management information systems and benchmark information.

• Ongoing development of the product or concept (very important in mature systems to stay competitive).

• Initial and ongoing training and support.

• Increased purchasing power.

• Coordinated marketing and advertising.

Cloete says there are many reasons why franchising may be a suitable business model – but an equal number of reasons why it may not be a good idea. “In general, from our side we recommend that businesses should only franchise if the model is already proven and will be profitable for potential franchisees.”

Things to take into account when seeking funding include such things as rents and bonds, tax liability and any fit-out or refurbishment requirements of the mall or franchisor.

“And given that it directly influences the bottom line, potential franchisees should also look at the transactional, merchant and personal banking package that the franchise system has negotiated on behalf of the franchisees of a particular brand. This is because they are effectively part of a buying group, which is another benefit of being part of a franchise system.”

“EVEN AFTER MORE THAN 20 YEARS, I’M STILL LEARNING EVERY DAY! FRANCHISING IS SIMPLE IN CONCEPT BUT COMPLEX IN ITS DESIGN FOR A PARTICULAR COMPANY.”

– CALLUM FLOYD.

To offer franchise (cashflow) lending to a business from a particular brand, Cloete would look at factors like the brand value, industry risk, competition, (other) franchisee performance, regular cashflow and documentation (including franchise agreements).

“As the bank would be lending against going concern value we would look at the business profitability (affordability), proven sale multiples, brand value (saleable), the term of the franchise agreement and the system action in event of default,” he says.

Impacting on the business value and the funding viability of the business are factors such as: franchise transfer clause restrictions, the quality of the GSA (General Security Agreement), and any goodwill payable to the franchisor on sale, brand damage or preferential payments.

AN ACCOUNTANT’S PERSPECTIVE

One of the first people who should be approached whenever there’s a sniff of a franchise opportunity is the accountant

– and it’s here where Philip Morrison, director of Franchise Accountants, reminds us that not all accountants are created equal and they have different specialisations.

“Often first time business buyers choose franchise businesses because they’re looking for that ongoing support. So they can be more vulnerable and must take duty of care. Choose an advisor with a proven track record [in franchising]. Often that’s not your family accountant.”

A specialist understands the industry and the unique points of difference in owning a franchise, he says.

Sitting down with a specialist accountant will soon reveal the viability of a particular franchise opportunity, says Morrison. His company has developed a software portal that provides a prepurchase evaluation for buyers in the form of a 25-page report. “A bit like a builder’s report when purchasing a house.”

Some accountants have a negative mindset towards franchised businesses, he says. “It’s often just lack of education around franchising and knowledge about how to evaluate a franchised business.”

Perhaps that negativity relates to franchise ‘war stories’ from the past – often these can be attributed to Diy-built franchise systems that didn’t undertake a franchise feasibility assessment before going to market. This can equally apply to taking up an overseas model that hasn’t been contextualised for New Zealand.

There is antedoctal evidence to support a proven franchise business system can be an attractive proposition as they have a low failure rate compared with an independent start up business.

“Do your homework,” advises Morrison. “Is the franchisor a member of FANZ (Franchise Association of New Zealand)? While this doesn’t provide a guarantee, it does provide a threshold of best practice for potential franchise buyers.”

Membership also provides some measure of franchisor peer accountability, protects franchises with a seven-day cool-off period after signing, and helps offer mediator solutions in disputes, he adds. And FANZ undertakes periodic checks on franchisors (on solvency, for example).

Morrison recalls one franchise evaluation that revealed poor modelling – where the numbers didn’t stack up. The asking price was too high, returns too low, and built on an over-optimistic sales forecast. Sometimes ‘no’ is the right answer for a buyer, he says. “It helps you clarify what you do want and what would work for you.”

CHALLENGES FOR FRANCHISORS

Callum Floyd, managing director of Franchize Consultants (NZ), works with a number of established franchisors to review and improve their franchise systems, and assists new franchises to get established in the local market. This generally begins with a comprehensive ‘Franchising Assessment and Feasibility Study’ and, if positive, is followed by other planning and important franchising infrastructure development – like franchise manuals, agreements, recruitment documentation and franchisor training.

He’s seen the considerable growth in the sector, the impact of new technologies, and, particularly in recent times, the increased competition for franchisees and end-user customers. It means franchise companies need to be more cognisant of their brand, value proposition and differentiation, and franchise support, he says.

There are a lot of boxes to tick before getting a franchise out of the starting blocks. Floyd emphasises the importance of proven profitability, ideally in multiple locations. “And situations representative of areas to be franchised.”

Also high on the list is the owner’s ability to understand their business model (including future needed changes), engage effectively with advisors to franchise the business, build effective relationships, and grow a strong support office team.

Think about the concept’s appeal to a potential franchisee, says Floyd. “Some very profitable franchise models have struggled to grow because people do not, for example, want to do dirty work – for example, clean up after animals, collecting accounts receivable, etcetera.”

Franchising, while powerful, is complex – and like anything, there’re myths and misconceptions surrounding it.

Some of Floyd’s favourites include:

• Franchising creates a passive income for the franchisor.

“Definitely not the case. We make it crystal clear that the franchisor’s role needs to be incredibly hands-on and it is demanding.”

• We already know it will be successful because we are successful and/or someone else is already doing it.

“Wrong. Your company may be successful as a companyowned operation but still might not be sufficiently feasible as a franchised operation. And others who’ve done it in a similar business might not be successful (despite appearances).”

• You can franchise without capital. “This is simply not correct. While sometimes costing less than establishing another company operation, a prospective franchisor still needs capital to fund a comprehensive franchise development programme and initial working capital to the point of break-even.”

Like any other business, franchising companies face an increasingly complex and dynamic business environment, says Floyd. “That means they need to be adaptable – a characteristic that doesn’t come naturally in franchising with a tried and tested business formula.

“From there they need to ensure they govern and plan the business comprehensively, applying the right resource, skills and focus, in order to innovate, improve and/or reinvent as needed. “Franchisors also need to ensure that they are focused on franchisees and their returns, and that they build credibility and trust with franchisees. They must engage with franchisees in planning and ideas so that when the time comes, franchisees are receptive rather than resistant to change. That ability to make needed system-wide changes is one of the great challenges in franchising today.”

WORTHY RECOGNITION

In November Westpac will host the 25th New Zealand Franchise Awards, and Simon Lord says he’s looking forward to highlighting the many success stories over the years.

He says while the success stories are largely ignored by the media – which prefers to cover any negative stories – they are deserving of celebration. As is franchising itself as a business model.

“Franchising suits Kiwis’ desire to be self-employed, but adds the training, support and buying power they need to be successful,” Lord reminds us.

“Corporates are increasingly taking over globally – but franchising allows local people to keep some of the action. And, of course, local franchisees pay local taxes.”