This is the numbers bit.

Like it or not, you need to read it.

Franchising will only work if both the franchisee and the franchisor are operating sustainable businesses, so that’s why any franchising plan starts with the numbers.

THE FRANCHISEE

Firstly we need to calculate, how will it work for the franchisee? How much will they need to invest initially, not just in the upfront franchise and training fees but in the acquisition of equipment, premises, vehicles, staff and so on. Once they are set up and opened, how quickly will sales start to come in and what will be the associated expenses? What ongoing fees will be payable to the franchisor? When will the franchisee start making a profit, and when will their cash flow eventually be positive? Will the business provide enough to repay loans, pay the franchisee an acceptable salary, generate a sufficient return on their investment, and still leave money over to invest in the development of their business?

Most of the data for the above calculations will come from actual results achieved in the existing business. The more sophisticated that business, and the more there is available in the way of branch management accounts, the better.

What will not be available from the existing business are figures for franchise fees, simply because none are currently being paid. This is where the need for experienced advice first comes in, and it is a good point at which to explain what these fees may be, and how the franchisor may generate his or her income.

The upfront fee

This is the amount a franchisee pays to the franchisor to get into the game, and it may or may not cover training, rights to use the name and systems, an amount which enables the franchisor to amortise his development and recruitment costs, an amount which reflects the perceived value of the opportunity or territory, and a small element of profit for the franchisor. It may also be calculated with reference to what other similar systems are charging, and the general market price for franchises, but it needs to be accurately assessed for each system. Just because a competitor is charging, say, £30,000 upfront fee doesn’t mean that’s the right figure for your business – it may not even be right for their business if they didn’t research it properly!

Many franchisors claim to make nothing from the upfront fee once they have deducted all their costs. Indeed some claim not to be breaking even with an individual franchisee until the latter has been trading, and paying ongoing fees, for at least a year.

Note that the upfront fee is not the same as the franchisee’s total setup cost, the latter of which includes all the other necessary purchases and expenses of getting an outlet opened. These may include acquisition of premises, equipment and vehicles; building works; shop fitting; initial stock purchases; staff recruitment and training; and various other items, the fees for which may go to third parties.

Some franchisors use the upfront fee in their franchise advertising, some use the total set-up costs. If you’ve seen figures in excess of about £40,000, they ought to be for total set-up costs not the upfront franchise fee.

Note also that a franchisor’s business is not about selling franchises and bringing in upfront franchise fees, although these will inevitably be important in the short- to medium-term. The long-term goal is to generate continuing income from successful franchisees.

Management services fees

Sometimes incorrectly referred to as royalties, these fees cover the ongoing services provided to the franchisees by the franchisor. The range and quality of services, and the level of management services fees, varies greatly from system to system – even for businesses in the same sector – and they need to be assessed and set by an experienced practitioner. They must be affordable, and good value, for the franchisee; they must be sufficient eventually to pay for the franchisor’s support infrastructure and to provide them with a reasonable profit, good return on their investment, and adequate funding to develop further the network and the business.

The majority of management services fees are charged as a percentage (anything between 4 per cent and 40 per cent, depending on the network) of the franchisee’s sales (not profit, not cash received) and they are most often payable monthly in arrears. Sometimes they are simply a fixed regular amount regardless of the franchisee’s performance, but the fairness and appropriateness of such an arrangement needs to be discussed with your consultant when initially creating the franchise structure.

Marketing fees

Many franchisors charge an ongoing fee, either a percentage or fixed amount, which goes into an identifiable pot to help pay for national marketing and branding activity. The application of such funds is usually accounted for to franchisees on an annual basis, and surpluses or shortages are carried forward as the pot is not intended to provide profit, or loss, for the franchisor. Local marketing activity on the franchisee’s area is usually a separate expense, paid for by the franchisee.

Product mark-up

For some franchisors it makes more sense, or it is more appropriate, to charge franchisees a mark-up on products supplied rather than a percentage, or fixed, management services fee. Sometimes franchisors charge both, but the temptation to take too much from franchisees in too many ways must be resisted if it affects the viability of their businesses. One of the advantages of being a franchisee is to benefit, not suffer, from being tied to, or part of, a bigger buying group.

Supplier rebates

Some franchisors receive retrospective discounts from suppliers based on the total sales to their network, others prefer to pass these on in the form of lower prices, or added-value services, to their franchisees. Either approach is acceptable, but it is better for the relationships if the arrangements are transparent.

To complete the financial forecasts for a franchised outlet, the preliminary decisions on all of the above are fed into the model, and the outcome is assessed. Based on all current, accurate information and best-informed guesswork, does it look like an attractive option for a potential franchisee who fits the desired profile? If it doesn’t, can any of the assumptions be (reasonably and credibly) adjusted to make it look better?

If so, do it.

If not, forget it.

All bets are off if the proposed structure cannot be made to work for the franchisee because, if that is the case, it will never work for the franchisor.

THE FRANCHISOR

If the forecast does work for the franchisee, we then move on to make sure it works for the franchisor.

Will there ever be enough franchisees, paying whatever they are going to be paying, to cover the costs of setting up the franchising business in the first place, and the ongoing costs of the support infrastructure that will be needed to support it? Unless you have done it before you will really need help here because there are many hidden, or naively overlooked, costs that go with establishing a franchised network. To name but a few:

• the Franchised Network Development Plan;
• territory analysis and demographic profiling;
• running pilot operations;
• preparation of the legal agreement;
• production of the operations manual;
• franchise marketing materials;
• launch marketing and promotion;
• employment of experienced staff;
• training of existing staff;
• membership of your National Franchise Association;
• associated professional advice of all sorts.

The total of such costs will vary from franchisor to franchisor, and from country to country, but in the UK you will typically have spent between £30,000–£50,000 on the above, in one way or another, before you sign your first franchisee.

You may think, ‘That’s OK, I’ll get most of it back from the first franchisee in upfront fees.’ However, even if that is the case, it does not mean that this is all the funding you need.

Consider how a franchised network develops. In the first year there will be few franchisees, probably five at best, and they will all be startup businesses. Their sales will not be as high as they will be when they are mature, so your total income from percentage management fees will not be very high. However, you will need to provide all the recruitment and support services outlined throughout this book to those early franchisees because if you do not, those early franchisees will not succeed.

If your early franchisees are not supported, and do not succeed, you will find it hard to recruit others. If you fall behind with your recruitment schedule you will run out of money, your business will fail and so will those of your early franchisees.

So you will be spending much more on support than you are receiving for providing it, and you will need to fund that from somewhere.

On top of that, if you want to recruit more franchisees next year, you will need to be spending more on marketing and recruitment activity this year. That means even more money going out than there is coming in. All the amounts vary from business to business, which is why you need an experienced practitioner to help with your plans, but it is not unusual for a franchising project to have a total funding requirement of £150,000 before it starts to make money.

After that, profit growth can be considerable but you need to do the cash flow projections to know where the challenges lie. The calculations are more complex than you think, which is why we developed our own FranchisedNetwork Builder software, but if you want to try it yourself there is a data collection template in Appendix C on page 245.

It doesn’t matter what the overall funding requirement is provided you know its extent and can put funding in place to cover it. What does matter is not knowing what the requirement is, then running out of money and leaving early franchisees exposed. The major clearing banks, certainly in the UK, are very supportive of franchising projects and they have their own specialist franchise sections to advise their business managers on lending to both franchisors and franchisees. Details are available on the British Franchise Association website, listed in Appendix H on page 273.

The beauty of the Franchised Network Development Plan is that its preparation involves discussion of all the relevant issues that are likely to come up as the business evolves, and it provides a comprehensive action plan of what has to be done, who is going to do it, when it has to be done by, and what it will cost.

Financial projections, both for profit and cash, are established and can then be compared to actual performance on a regular basis. Assuming the levels of investment and return are considered acceptable all that has to be done is to press the button and get on with it.

A typical franchise development work programme is given in Appendix A on page 240. Examples of a contents list for a Franchised Network Development Plan, and of the financial forecasts, are presented in Appendix B and Appendix C respectively, on pages 244 and 245.