Franchising has helped hundreds of thousands of individuals becoming small business owners in the UK, but is it suitable for you?
Owning your business through franchising can be hugely rewarding, as it uses a business model that has been proven successful, so much so that fewer than 1% of franchisees fail, according to a comprehensive 2018 study done by BFA and NatWest. In comparison, it is estimated that 60% of new businesses will fail within three years according to this 2019 article by the Telegraph.
As a franchisee, you pay fees to a franchisor who is usually an established company that licenses its brand, process and know-how to you. Essentially a franchisee is a person who is a self-employed business owner but with limited control on how you can run the franchise; you must follow the strict procedures laid out by the franchisor whom you choose to work with.
Although popular, franchising isn’t for everyone. In this article, our small business accountants at Tax Agility aim to discuss the top five points you need to know about franchising:
- Types of franchises
- Advantages of running a franchise
- Disadvantages of running a franchise
- Key considerations
- The importance of due diligence
Hopefully at the end of the article, you would have a better idea if franchising is something that you would like to pursue or not.
Types of franchises
Every franchise is slightly different in how they are managed and generally they can be broken down into three main types.
1. Business format
This is the most common type and is widely used by fast-food companies. What it means is that you buy the right to use the franchisor’s intellectual property, systems and products for a fee over a set period of time as specified in the contract.
Under this arrangement, it is common for the franchisor to continually influence the franchisee by setting guidelines and goals, as well as offering training and support.
2. Product distribution
In this case, you (the franchisee) is given the right to distribute a manufacturer’s products within a specific territory or at a specific location. Your business may not trade under the franchisor’s name but you may choose to display the manufacturer’s brand prominently in your business premises. An example is a car dealership where you sell the franchisor’s products directly to the public.
3. Processing or manufacturing
In this model, you (the franchisee) produce or manufacture the products, following the exact formula or know-how given by the franchisor. For instance, a chocolate maker licences its recipes and packaging to franchisees.
In addition to the above, there are also other types of franchise arrangements like agency, license and management.
The top five advantages of running a franchise
1. An established brand
Your franchisor is well established and ready to let you use their brand, reputation, as well as products or services.
2. A support network
Your franchisor is likely to have an extensive business network with incredible power to assist you with lease negotiation, shop fit-out, equipment, management training and ongoing support. Some franchisors go even further to provide legal and logistical support to their franchisees.
3. No experience required
Quite a few franchisors are not dissuaded if their potential franchisees have zero business experience as they offer training and give tools to help their franchisees succeed. Instead of experience, some franchisors may look for franchisees with leadership skills, passionate about the business and a willingness to learn.
4. Less concern over market trends
When running your own business, you need to continuously develop products or services that are relevant to your customers, otherwise you risk losing them. When you are a franchisee, you tend to worry less about market trends as usually your franchisor takes on this responsibility.
5. Almost guaranteed success
The success of franchises is supported by data. In the 2018 franchise landscape study done by BFA and NatWest, there were about 48,600 franchised units in the UK with 6 in 10 of them enjoyed a turnover of more than £250,000. Among them, 93% of franchisees claimed profitability in 2018. The data show that as long as there are proper due diligence, good management and good support in place, there is not a lot to hold a franchise back from becoming profitable.
The top five disadvantages of running a franchise
1. It is costly
For all the success that franchising can offer, it is often forgotten that the initial start-up costs to gain access to a franchise can be very high. It is not unusual to see a franchisor wanting at least £50,000 from a franchisee and often hitting six figures for a fast-food chain.
On top of that, you also need to secure a location, get equipment, buy stock, employ staff and get the business going. While some supplies will be provided by the franchisor, there are bits and pieces that you need to make your own purchases. Additionally, you will need to pay a regular fee to the franchisor irrespective of whether you turn a profit or not.
2. Your control can be limited
Your franchisor has given you the platform to succeed, but no matter how successful or profitable you make your franchise, the franchisor remains in control and shares your success. The only growth path for you is to license more franchises from your franchisor.
You also have less autonomy when it comes to making business decisions, as you are usually required to operate the franchise according to a standard operating manual.
Also, when you decide to sell your franchise, you have strict procedures to follow. Some franchisors also want to approve your buyer first. In other words, you have less control in a franchise than in managing your own business.
3. Your ideas (and franchises) are never your own
Jim Delligatti became a McDonald’s franchisee in 1955 and thought up the concept for the Big Mac 10 years later. Despite the global success of this iconic burger, Delligatti never received any royalties for his creation but a plaque.
Being a franchisee may mean that you are self-employed, but unlike running your own company, you do not have the creative freedom in a franchise. So if you are someone who loves the freedom to innovate, generate ideas and think outside of the box, franchising may not be right for you.
4. Bad performances by other franchisees may affect your franchise
When something bad happens in another franchisee like when they don’t follow strict hygiene procedures and customers get sick, it tends to affect other franchisees and you have no control over it.
5. Franchisors can refuse to renew your contract
When it comes to getting a franchise contract renewed when the previous contract is up, a franchisor may not elect to renew your contact irrespective of how hard you work or how successful you are.
Franchisors can choose not to renew for a number of reasons, such as if they think you are not performing as well as they want or if there has been non-payment of fees. In fact, any minor breach of the agreement could result in the franchisor pulling out the rug from under you. When this happens, the business and its goodwill go back to the franchisor.
Apart from the main advantages and disadvantages of owning a franchise mentioned above, there are other areas which you need to consider as well.
1. Do your research
In London, there are at least a few hundred franchising opportunities available at any one time so take your time to research. Beware that some franchisors may inflate earning potential claims.
2. Look at hard data
To help evaluate your options, ask potential franchisors for specific data including financial information (this should include past and projected financial data), information on previous and current franchisees, disclaimers, as well as market reputation.
3. Ask other franchisees
Good questions to ask include:
- How long did it take them to recover their investment?
- What is their profit margin?
- What are the hidden and unexpected costs?
It may worth getting an independent accountant to look at the numbers before you make a commitment.
4. Match your desire
Running a franchise means you must adhere to strict procedures, even if you do not agree with them. If you are after creative freedom to carve your own success story, then franchising may not suit you.
5. Match your personality
With so many opportunities available, find one that best fits your personality. For instance, if you are ecologically-minded, choose a franchise that promotes green energy, environmentally-friendly cleaning products, or a natural make-up range, to name but a few.
6. Work out your finances
Buying a franchise requires a substantial fee upfront, anything from the license fee to vehicle cost and/or premises rent. Work out how much money you need and how you are going to raise the fund.
Addressing all the points above should help you to decide whether or not franchising is suitable for you. At the end of the exercise, you may realise that instead of becoming a franchisee, you actually want to go into a business by yourself or with a partner. You may even be thinking of buying an already established small business, which may be less costly than buying a franchise while affording you the freedom to change the business as you see fit. If this is on the cards, this article The complete guide to buying a small business may be useful.
The importance of due diligence
Due diligence refers to the process in which you investigate, verify and confirm the claims made by the other party before entering into a contract with them.
Before making a large investment (in this case buying a franchise), you need to conduct due diligence by verifying the franchisor’s business practice, financial performances and even statutory obligations. The objective is to mitigate risks and avoid any unforeseen liabilities.
Good due diligence often starts with financial data and tax compliance but it quickly extends to include areas like legal, intellectual property, statutory and even environmental due diligence. As you are after sensitive data, some franchisors may ask you to sign a non-disclosure agreement before they can share the information with you; this is a common practice.
While you are likely to rely on your accountant and solicitor to assist with financial and legal due diligence respectively, you can definitely tap into your business acumen and conduct business due diligence accordingly. Some business questions may include:
- Why has no one set-up a franchise in this particular area previously?
- What market research can you conduct to determine demand in a local area?
- How intense is the local competition? Are prices competitive?
Tax Agility is here to support small business owners
Deciding on the best route into business ownership is dependent on a number of factors such as the opportunities in front of you, your skillsets and the budget at your disposal. Whether it is the world of franchising, launching a start-up or buying a pre-existing business, there are advantages and disadvantages inherent with each of these entry points.
Despite some differences, these three pathways share one common hurdle to overcome: finance. Before making any decision on which option you want to pursue, it is important to do your due diligence and get sound financial advice that can help you decide wisely. At Tax Agility, we provide expert consultancy to entrepreneurs across London who are keen to get into business ownership for the first time.
Our chartered accountants for small business owners are here to offer solid advice on all matters relating to accounting and tax. We care very much about your success, which is why our advice is always centred around what is best for you and your business. Think of us as your financial controller but without paying big money. Use our expertise to help you make sure the financial side is strong, so you can focus on running the business.
Our accountancy, tax and payroll services are used by small and medium-sized businesses ranging from start-ups to franchises to established companies. Call us now on 020 8108 0090 to discuss how our small business accountants can help you.
You may also be interested in:
- The complete guide to buying a small business
- Small Business: 5 ways to get new customers
- Accounting tips for small businesses
- How to find a good accountant in London
This blog is a general summary. It should not replace professional advice tailored to your specific circumstance.