Can you afford to franchise your business?

Most businesses that franchise don’t have enough capital at the outset.

The lack of capital to grow is a fundamental reason why businesses adopt franchising as their growth strategy in the first place. This is referred to as the capital constraints theory to explain why franchising occurs.

The difficulties arising from a lack of capital for start-up franchisors can be due to an underestimation of the costs involved, or the requirement to outlay money in preparing the business for franchising before it can actually receive any external capital from franchisees joining the system.

So whether a business franchises or not, it is still likely to face the problem of a lack of growth capital.

So how much do you need before you start franchising?

The answer will depend on your individual circumstances and existing preparedness.

If you do not have the funds to open and operate additional outlets to demonstrate proof of your concept, you will need a lot more capital before franchising than other businesses which already have multiple outlets.

Establishing additional outlets to determine proof of concept may be necessary regardless of whether or not franchising is chosen as the preferred growth strategy, so it could be argued that this is a generic capital requirement, rather than one specific to franchising.

Likewise, refining and documenting your operating procedures, and establishing monitoring systems to remotely assess the performance of outlets could also be argued as a cost that must be incurred regardless of whether franchising or some other multi-outlet method of growth is chosen.

This would leave the cost of developing franchisee recruitment procedures and promotion, training and induction systems, plus the cost of legal documentation as the only costs specific to franchising that potentially won’t be found in other growth strategies.

For these costs alone, the capital required will vary according to the nature of the business itself.

If, for example, the business is a mobile, home-based service business, these franchise-specific costs could be roughly equal to or slightly greater than the price at which franchises may be subsequently offered. (e.g. if it is anticipated that future franchises will be offered at say $30,000 each, then it is likely that the start-up franchisor will need to spend this much up front to cover their franchise-specific costs).

If on the other hand the business is a fixed location service or retail business with much greater complexity than a home-based service business, and consequently will incur greater expense after fitout, equipment and stock for a franchisee to acquire, so too will the franchising-specific costs be greater in overall dollar terms, but lower as a proportion of a future franchisee’s investment.

For example, if a coffee shop is to be franchised and would be offered to potential franchisees at an initial all-up investment of $250,000, then the aspiring franchisor would probably incur franchising-specific costs of somewhere between one-fifth and one third of this amount (i.e. between $50,000 and approximately $80,000).

Remember that the examples given above refer only to franchising-specific costs, and that significant other costs will be incurred to establish proof of concept, system documentation, and monitoring systems regardless of whether franchising or another multi-outlet growth strategy is chosen.

Only after these costs have been incurred is a business truly ready for franchising, so if it doesn’t have sufficient capital to cover these outlays from the beginning, then its chances of franchising successfully are limited.

In spite of this, there are many entrepreneurs who proudly claim that they started franchising their businesses without any money, but then later admit they would do things very differently (with a lot more planning and capital resources beforehand) if they had their time over again.

Business owners thinking of franchising their business must be cautious to fully assess the costs of firstly preparing their business for growth, and then preparing it for franchising before committing to a course of action.

Franchise consultants offering to franchise your business for you for a five or six figure sum should be queried in depth about the proportion of the fees that will be expended on generic preparation for growth, and the proportion of fees that will be expended on franchising-specific costs.

If you are not satisfied with the answer provided, or feel that the costs involved are prohibitive, then be prepared to walk away. After all, franchising is a great way to grow a business, but it’s not the only way to grow a business.

Jason Gehrke is the director of the Franchise Advisory Centre and has been involved in franchising for more than 20 years at franchisee, franchisor and advisor level. He advises potential and existing franchisors and franchisees, and conducts franchise education programs throughout Australia. He also publishes Franchise News & Events, a fortnightly email news bulletin on franchising issues and trends.