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buying a franchise: financial matters

Philip Morrison looks at how to calculate whether a franchise is a worthwhile investment

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f you’re looking at buying a business, there are two key things you need to know: first, can you afford to buy it and, secondly, will it produce the return you want? Last issue, we explained how to evaluate your financial position to work out what you can afford – you can read that article online at www.franchise. co.nz/article/2397. To make it easy to understand, we created a theoretical case study of a prospective franchisee called Arthur Hunter and took him through three stages: 1. Working out his personal equity, or net worth; 2. Working out the maximum price he could pay for a franchise, including borrowing; 3. Working out what income he needs to live on, including KiwiSaver and mortgage payments. As a result, Arthur worked out that in his current situation the maximum he is able to spend on a business is $260,000, and he needs it to provide a minimum gross income of $79,120 – in addition to whatever rate of return on investment he and his accountant decide is acceptable. When we left him, he was in the position of starting to get financial information from the franchises he was interested in. What he now needs to do is look at that information and see how it compares to his financial situation. Understandably, franchisors are wary about parting with detailed financial information about their business model, so we’ll continue using a fictitious example here.

projections are not guarantees

Something to be aware of is that any figures provided for new franchises are only projections based upon the franchisor’s model and experience in other locations. Although an experienced franchisor should have a good knowledge of the real costs of running the business, they can’t know for sure what level of sales will be achieved in any area before that business opens. The figures provided are therefore not guarantees of performance: just a starting point for further analysis. As a potential franchisee, it’s up to Arthur to determine the assumptions on which the projections are based before placing any reliance on them. This reinforces how critical it is to seek independent assessment of the numbers from a franchise-experienced accountant who has benchmarking data based on like-for-like business performance. Of course, if Arthur looks at buying an existing franchised business, there will be specific data available for analysis (see Understanding the Numbers at www.franchise.co.nz/article/36). However, care must still be taken to ensure that the figures provided by an outgoing franchisee are realistic and accurate.

what’s included?

Here are some questions that Arthur should ask the franchisor to ensure that the information he receives is truly relevant to his own potential business: • Are the projections based on actual performance of other franchisees, or are they calculated on some other basis? • If they are based on actual performance of a franchisee, where was the franchisee located? Why do you believe that this experience is relevant to my planned location? If the franchisee was located in a CBD and Arthur is looking at a provincial location, both sales levels and costs – eg. rent – are likely to vary considerably. Arthur needs to be able to compare like with like. • If the projections are not based on actual performance of existing franchisees, how were they determined? • How long has the business been operating? • How realistic, given my location, is it for me to achieve the sales that you have predicted in the projections? • Can I discuss these projections with an existing franchisee? • What amount of working capital do I require? Is this working capital to be maintained throughout the life of the business or only in the start-up phase? Is working capital included in the quoted franchise investment, or is it additional? • Do you plan to open any further outlets in my city/town/suburb? If so, how might this affect my business?

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Summer 2019

Year 27 Issue 04

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