Financial considerations when franchising your business
So, you’ve decided to take the leap into growing by franchising… or, perhaps, you already have started franchising and are wondering if you’re doing things in the best way?
Author: Carl Reader, Chairman at d&t, a leading franchise financial specialists
I’ve personally worked with hundreds of brands, both in the UK and internationally, and a common theme that I have found is that often people don’t know the benefit that they can have by addressing the financial systems and support in their operation from day one.
Yes, you might have your own accountant and your own funding broker, but it’s unlikely that they are as integrated in the industry as specialists such as d&t.
In fact, the thought going through your mind right now is “this can be tomorrows problem”. Hopefully I can help you think otherwise – and it doesn’t cost anywhere near what you’d expect.
What should you be thinking about when designing your franchise system? First and foremost, the most important thing that you should be thinking about is unit level economics. The great franchisors, both domestically and internationally, know that profitable franchisees build a long term sustainable franchise network that has true value to everyone involved.
Whilst that might sound like a catchphrase that ignores the commercial reality, those who’ve trodden the path before know that relying on the management service fee (MSF), or even worse the initial fees alone, creates a split between franchisor and franchisee.
The unit level economics dictate whether your potential franchisees can get funding for their franchise from the banks on preferential terms, whether the model is attractive once they get independent advice, the morale of the network during their term and of course, the likelihood of both referrals and renewals.
Once we have that mindset in place, we can then turn to the practical steps that you can take to support your network:
Assisting new franchisees with funding Whilst you might hope that you will stumble across several billionaires who will happily pay you in cash, the reality is that most new franchisees tend to need some level of funding.
By having a process in place to help them through this, you can ensure that they avoid the trap of speaking to their local bank manager, who will likely be unaware of the preferential lending terms available to prospective franchisees of proven brands.
You can do this yourself; however there are quite a few risks in this. For a franchisee to successfully raise funding, they need a strong business plan which has truly considered the realistic chances of success, and the various matters that might impact the business on both a local and national level.
As a franchisor, you’ve naturally got a vested interest in them achieving funding as it will secure you a new franchisee. And as an accountant by training, I’m fully aware that you can easily become a spreadsheet millionaire by hitting the zero key on your keyboard a few times!
What’s more, as a franchisor, you could potentially open yourself up to liability risks should the franchisee not perform as planned. Many franchisors are aware of the misrepresentation risks that come with initial material provided to prospects, but these risks also apply to information you provide to them directly in detailed projections or templated business plans.
So, the best route is to find an independent funding broker, but not just any funding broker. I’d recommend that you ask them three questions to check that they are the right fit for you:
Ask them if they are truly independent. A ‘broker’ who is tied to one or two finance companies isn’t a truly independent broker and you can’t be assured that they are getting the best deals for your franchisees.
Ask them if they truly get franchising.And ask again! So many new finance companies pop up and put the word ‘franchise’ into their branding. Ask how long they’ve been working actively in franchising with more than just 10 or so brands, how many brands they work with, etc. Really dig deeper to understand whether they are just putting a marketing strapline onto their website, or if they are truly integrated into the industry.
Don’t fall for the ‘spreadsheet millionaire’ trap! Yes, we talked about it as a risk for you as franchisor – but there is also a risk your broker has the sole focus of getting the deal done too. If the only service they provide is funding; with no follow up accountability on those plans, then it is likely that their main source of income is based on success fees. Again, this might help you today but decimate your unit level economics tomorrow.
Creating a system to manage your networks finances Being in franchising since 2006, this is probably the area where I’m most amazed at the differences between networks. We all know that finance is the language of business, but it’s very rare that franchisee and franchisor speak the same language!
The very best in class franchisees have a system that consolidates and provides analytics of their networks performance – not just their sales (which is where the MSF comes from) but also their profitability. There are two ways in which you can do this:
You can build it yourself. If you have experience of Application Programming Interface (API) connections between various packages, the risks of different charts of accounts, and coding experience you’d be able to create a consolidation tool that works.
You can use an existing system, for example d&t’s free of charge Franchise Dashboard, which helps you hit the ground running with the insights you need to manage your network.
Once you’ve got a system, this is where the magic kicks in!
If you use a holistic provider that manages both the planning (through funding applications) and the results (through filing of accounts and tax returns), you can not only monitor what happened 18 months ago, but also compare against what was planned to happen. This can help you drive performance, and in turn happiness, through your network – whilst also being able to spot when things aren’t quite what they seem.
Appoint a mandatory accounting partner in your franchise agreement Under the EU Block Exemption for Vertical Agreements, you are permitted to enforce certain suppliers that are integral to your network, and we all know that financial management is vital to both the health and the performance of each and every franchisee.
It is much tougher to justify enforcing a generic accountant who uses off the shelf systems, but when you have one that also provides the network infrastructure to manage the finances of the entire network it becomes a no-brainer.
When choosing your partner, again you should follow similar questions to those mentioned above about their longevity and experience in franchising, and working with concepts that are similar to yours.
The kind of things that a reputable accounting partner would suggest, without you prompting them, would be:
A mandatory chart of accounts to ensure that you are comparing apples with apples and that the information is similar across the network.
Structuring of your initial franchise fees and an explanation of the tax differences between training and secondary training, for example.
Practical KPIs to monitor within your network.
Joining up budgets vs activity vs results.
A reporting structure to head office.
Ultimately, whilst franchising itself isn’t a complicated method of growth, it needs the right foundations to ensure success.
The usual objections to a mandatory accounting partner is the perceived fear of a franchisor that ‘it would be offputting’. Thankfully, those fears can be allayed by our experience.
Firstly the stats show that over 70% of new franchisees are starting their first or only business, and that the remaining who already have a business are likely to be more established multi-unit franchisees.
Secondly, they need to pay for an accountant anyway. Surely it’s best for them to get one who knows how every other franchisee in the network is doing, so that the advice is specific and based on much more knowledge and experience than a generalist.
Look at the data more than once per year Yes this sounds obvious, but you’ll be amazed how many franchisors rely on paper accounts being emailed/posted 18 months after the start of the financial year. That simply isn’t good enough.
Check in regularly, monitor their bank balances, costs and income, and be there for them to support them.
The best in class have systems which allow them to do this daily if they wish, but if you have a disjointed system with different accountants and potentially differently structured bookkeeping packages (or perhaps even worse, using more than one bookkeeping package), I’d suggest employing someone to monitor these things weekly or fortnightly. Of course, it might be far easier to appoint a network accountant with these tools already in place.
Take focused action rather than carpet bombing As a knock on effect of a lack of systems, many brands manage their franchisees with a big stick, in the same way.
Franchisee management visits become a checklist, to make sure that the logo is on the wall, the floor is clean, and so on.
Instead, why not use the data to help you identify who you can serve and how you can serve them?
By tying up budgets vs activities vs results, you can support your bottom 20% with whatever assistance they need, and work with your high flyers to identify the key traits and activities that make them stand out amongst their peers (ps hint – it is likely to be their focus on the stats, and taking action!)
Finally, sleep at night Once you’ve got your financial processes in hand, it’s a job well done. And if you’ve appointed the experts, it takes little intervention afterwards.
Whilst I appreciate these things can be tough to get your head around, our team at d&t are more than willing to help you and hold your hand through this process.
From setting up your systems from day one, through to converting franchise networks with 500 locations on to a better way of doing things, we’ve been there and we’ve got your back.
About the author
Carl Reader is Chairman at multi-award winning franchise accounting firm d&t and author of The Franchising Handbook. He has previously served as Affiliate Chair and Board Member at the British Franchise Association.
Reader has spoken to global franchising audiences about best practice in franchising, and has worked with countless household name brands.
He has been recognised as one of the ’20 faces of franchising’ by What Franchise magazine, is a judge of many industry awards, and regularly contributes to the trade press.