Buying into a franchise can be a rewarding business decision – but with so many franchise systems out there, how do you go about choosing the best one for you, and then funding it? Rebecca Spicer investigates
From dog washing and home maintenance to juice bars and fitness gyms, the list of franchise models in Australia is long, and the options for potential franchisees are daunting.
Before starting to sift through these, you need to be sure a franchise business model is right for you. "Some people are suited to having an employed job, others are more suited to, or prefer to run, something completely independent," says Adrian McFedries, director of franchise consultancy, DC Strategy. "Franchising represents an opportunity to be in business but at the same time be part of a broader network."
A major benefit of entering a franchise is that it can significantly reduce the startup risk of a business, explains McFedries. This doesn’t mean it’s foolproof, though. With the number of franchise systems per capita in Australia being four times higher than in the US, it’s a competitive market and one that requires dedication and flexibility by the franchisee to fit within a franchise structure.
From a funding perspective, Jason Cannock, national manager of retail and franchising for ANZ Bank, agrees that franchises have a lower propensity for failure than an independent business. "This is because the franchise system has been in existence for some time and has a developed model and a brand recognition that any new franchisee can leverage.
"That said, it is still critical that franchisees complete a thorough due diligence to help determine if it’s the right business for them. This includes assessing the operational history and competitive advantage of the franchise, existing franchisee satisfaction, marketing and franchisor support and, most importantly, what level of success they expect to achieve."
Mitch Jones, a 19-year-old who opened the 60th Cold Rock franchise in Victoria’s Berwick earlier this year, says the lower risk level was a big drawcard. "I thought to get the stability and predictability that a franchise offers was the best way to get into the small business field, and it would give me good backing for when I wanted to go out and do something on my own."
Risk was also a consideration for Susan Mason when she decided to buy into the Mortgage Choice franchise six years ago. When her husband became ill and, under doctor’s orders, had to stop work, it was up to Mason to support her young family financially. Despite the risk of going into business, she had some experience under her belt and felt this was how she could earn the highest income. "I knew that being self-employed gave me the capability of determining my own income level by my own results," she says.
Choosing the type of franchise business to enter will largely depend on what the business owner has a predisposition to, explains McFedries. "So, do they want to be a mobile operator or do they want to be in a bricks and mortar type franchise? Do they want to be business-to-consumer or business-to-business? At a very high level it’s about what people think they’ll enjoy."
With a background in real estate and automotive finance, mortgage brokering felt like a good fit for Mason, and it was a growth industry at the time. "While I probably had a stronger background than most Mortgage Choice franchisees going in, I didn’t want to completely wing it by myself and be an independent broker and have to negotiate commissions with lenders and so on. The Mortgage Choice franchise model gave me the support I wanted, so I’d be able to get in and concentrate on building a business."
Your budget is another major consideration, and this means sitting down with a banker or accountant to work out exactly how much capital is available. It’s important that potential franchisees have a budget slightly more than the entry price to cover additional startup costs, McFedries adds, and the extent of this will depend on the size of the franchise and the entry fee.
These additional costs vary, especially if comparing a shopfront to a mobile franchise. Retail outlets, for example, will need to allow for fitouts and so on, but the best thing to do is to speak to other franchisees to understand the experience from them.
"We were lucky because we went into a brand new store, so our fitout costs were quite low," says Jones. "Nevertheless, I’d still add at least 15 percent to cover startup costs. It’s just little bits and pieces that can add up." Jones also spoke with at least 20 other Cold Rock franchisees to gauge what his expectations should be and how to make the set-up most seamless.
Another choice is, whether to buy an existing franchise business or start a new one. "It’s what we call the primary versus the secondary market," McFedries explains. "The primary market is for greenfield sites, and the secondary market is resale activity.
"If you want to buy a local franchise which has been built up over a few years, that will come with some goodwill attached and you’re going to pay a little extra for it. But as an established business it should have good commercial returns, and as a result you’ve got less startup risk.
"However, some people are more predisposed to buying a greenfield site because they back themselves to build a business and they don’t want to have to pay for somebody else’s goodwill."
Marwan Kojok, director of Baybridge Lawyers, franchise specialists, says there are also different legal aspects involved with these two scenarios. "When buying an existing franchise there’s a contract for sale of business. They need to ensure the contract meets their expectations, they’ve done their due diligence in respect to that contract and they’ve sought the appropriate advice."
McFedries recommends doing as much background research as possible on a range of franchises, and once the options are narrowed down to about five potentials, set up face-to-face meetings with the franchisors. He also recommends talking to more than one in any given franchise sector.
During these meetings, he says, it’s important to establish the franchisor’s background, asking questions around how much time, money, and effort they’ve put into setting up the franchise system. This will give an indication of the level of foundation, support, infrastructure, and systems that the franchisor will be able to offer. And, a clear understanding around the financial proposition is important, particularly the establishment costs.
Through her interview process, Mason requested to see Mortgage Choice’s balance sheets. "Most franchisors probably wouldn’t do it, but we thought if we’re signing up to a franchise agreement—and at that time they weren’t a publicly listed company—we wanted to know how strong they were. They were very open, and that’s one of the things that appealed to us—they had nothing to hide." Mortgage Choice was also forthcoming about how long it would take Mason to start getting a return on her investment.
When it came to background checking, she went to the Franchise Council of Australia and the Department of Consumer Affairs to ensure the franchise hadn’t had any complaints or legal proceedings brought against it.
t;We chose Mortgage Choice for a number of reasons. A lot of it was really around where the franchisor thought they were going, and where Mortgage Choice stood out strongly was the ethics behind it. And their business model was all about empowering the franchisees with knowledge, expertise, and tools to let them advance themselves."
Realising there was no ice cream store in the Berwick area gave Jones his direction when researching franchise options. He spoke to three different ice cream franchises and one other before settling on Cold Rock. "I was looking for stability, honesty, and something a little bit different," he says. "In this state, we’re the fourth Cold Rock store and I think we can definitely support 20 in Victoria, so to be one of the first stores to come out here was what grabbed us at first. Then there’s a lot of people at head office who know where they want to take the franchise, and I want to be heading in that direction as well."
With all there is to consider when entering a franchise, it’s important to seek advice from a number of professionals. Your accountant or banker will advise you on your financial position, and your accountant will also be able to help you value the business if you’re buying an existing franchise.
"It’s important that the financial aspect of the business meets their expectations first," says Kojok, cautioning to make sure set-up costs fit within, and the valuation of the business meets expectations after due diligence is complete.
"Once they’ve done that and they’re satisfied, then it’s a good time to have a lawyer review the documents and negotiate the terms." And it’s very important to engage a lawyer experienced in dealing with franchise systems, he adds.
From a legal perspective, potential franchisees should understand there is a Franchising Code of Conduct regulated by the ACCC, which outlines the rights and obligations of franchisees and franchisors. A lawyer will be able to explain this properly, and will also go through the franchise agreement to ensure it complies with the code, and to explain any legal jargon.
In terms of funding your franchise purchase, the entry price to buy into a franchise can vary greatly, from tens of thousands to $500,000-plus, so unless you’re like Mason and are able to cash in on investments to fund the purchase, you’ll probably need to acquire finance. "I would say the majority of franchisees would be taking on some form of debt. Sometimes that’s an overdraft, sometimes it’s a mortgage secured against their house, and sometimes it’s a mortgage secured against the franchise," explains McFedries.
"Generally, the amount franchisees borrow should always reflect the ability of the business to generate sufficient cash flows to repay all business and personal commitments and living expenses, and provide a reasonable investment return," explains Cannock.
"We strongly recommend that a franchisee contributes a reasonable deposit (up to 50 percent) to the purchase of the business. This will ensure that their business is not overburdened with loan repayment commitments before it has the opportunity to generate a sustainable level of cash flow."
Over the years, the lending for franchisees in Australia has become more sophisticated. There is now an accreditation process franchisors can go through with certain banks, which could translate into a better lending rate for franchisees because the bank has taken some time to understand them. It’s worth checking with franchisors if they have such accreditation.
"ANZ has developed relationships with many franchise systems and is able to offer special lending packages that allow potential franchisees to raise part of the purchase price against the value of the franchise they are purchasing," Cannock says.
Jones was able to secure finance through ANZ, with his father as guarantor. And while his store was the first Cold Rock in Victoria to use ANZ finance, other stores in the franchise system had used the bank, setting a good example for new franchisees like Jones.
"Lenders look for franchisees who are able to demonstrate that they have thoroughly researched the business or franchise they are acquiring," Cannock explains. "This will include a comprehensive business plan and a strong understanding of what is required for the business to be a success. Other critical elements that are taken into consideration include appropriate financial backing, business acumen, and experience in the relevant industry.
"A strong franchise system will be one that has high brand and product recognition, a differentiated competitive offering, excellent growth potential and future plans. Importantly, it will also have a demonstrated track record in supporting the interests of franchisees to help them achieve their growth aspirations."
Exploring Your Options
Official Franchise Council of Australia online directory— www.franchisebusiness.com.au
Seek Commercial— www.seekcommercial.com.au
Business Opportunities expos— www.businessexpo.com.au
Trade publications, local and weekend newspapers.
Use the internet to do background research and find franchisor’s websites.
Walk into a store you’re interested in and ask the business owner about any franchise opportunities.