Buying a franchise: what you need to know

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LESSON LEARNT Sanet and Marius will plan more carefully before going into a franchise agreement again
LESSON LEARNT Sanet and Marius will plan more carefully before going into a franchise agreement again


Like many people, Sanet and Marius saw owning a franchise as a way to earn some extra cash. “We bought a food truck waffle franchise as a way to make extra money. We were hoping that, over time, we could turn it into a full-time business,” says Sanet.

The figures provided by the franchiser claimed they could make money, and friends who had eaten the waffles at a local market attested to the fact that they were a great product. On this basis, the couple took out a personal loan for R200 000 to purchase the food truck, with a monthly repayment of R7 000. The contract committed them to a monthly R5 000 franchise fee. This meant the first R12 000 of turnover from the food truck went straight to the franchiser and loan repayment.

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The couple were selling the waffles at R60 per waffle – they had to sell 200 waffles just to meet their obligations. This is before they paid for stock or for their time. Most weekends, they were only able to sell 30 to 40 waffles.

When Absa financial adviser Pieter Myburgh and Absa national business development manager for fast-moving consumer goods and consumer services Abigail Makhubele looked at the business, it was clear the couple could not realistically meet the required figures.

Myburgh said: 

Looking at the income they generated from the franchise, there was simply not enough income to cover the operations.

In the contract agreement, the franchiser took no responsibility for the validity of the numbers they had provided. Furthermore, the contract limited them to a specific area, which included only one market where they could operate. There were simply not enough venues for them to sell their waffles.

“This is not the first person I have met who entered into a franchise agreement blindly,” said Myburgh, adding that many people get excited about an idea without asking the right questions, or asking a legal expert to examine the contract or an accountant to assess the financial viability.

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Although the couple were committed to the contract for several years, Myburgh and Makhubele assisted on writing a letter to the franchiser, raising the list of issues and broken promises. The franchiser agreed to release them from their franchise agreement and the R5 000 monthly franchise fee. The couple are now in the process of selling the food truck to help settle the loan. They are fortunate that the franchiser did not go the legal route, which would have led to further expenses.

“This is a problem we see all the time,” says Makhubele, who adds that franchise agreements are often heavily in favour of the franchiser, with little recourse for the franchisee. “The franchiser usually has much deeper pockets than the franchisee, who is already struggling to make ends meet. They cannot afford to go the legal route and incur legal fees.”

Sanet says: 

It was a hard and expensive lesson. If we decide to buy a franchise in the future, we will make sure that we follow the right channels, do our homework and meet with professionals to guide and assist us through the process.

A good franchise can be a great business, but you need to do your homework and understand the commitment required.

“Not everyone is cut out to be a franchisee. It takes hard work and commitment,” says Absa national business development manager for fast-moving consumer goods and consumer services Abigail Makhubele. Many franchise stores will be in shopping centres that are open seven days a week. You will be expected to be operating during mall hours, as well as on public holidays.

“This is not a business for someone who wants to be with their family over the weekend,” says Makhubele, who adds that, as a franchisee, you need to abide by the rules of the franchiser and maintain standards.

While a good franchiser will be there to support you, you need to have your own team and be self-motivated: “It is not a franchiser’s job to babysit you.”

The advantages

. A franchise offers a proven concept and, therefore, reduced capital needs. When the franchisee acquires an outlet, they only invest in their outlet.

. Accelerated growth due to increased buying power and marketing clout that is formed by the franchise system.

. Franchisees become brand ambassadors and create a support network among themselves. The franchisees become intelligence gatherers on what works and what doesn’t, and assist the franchiser to fine-tune the franchise operations.

. Hands-on franchiser operators are advocates for underperforming branches and have resuscitated poorly performing stores.

The challenges

. Set-up costs: There are significant set-up costs to comply with the brand look and feel and standards set up by the franchiser.

. Long time to break even: Due to the set-up costs and time to build your market, initial operating losses are inevitable. Makhubele says a franchisee needs to have enough cash flow to support the business for the first six to 12 months. One cannot rely on borrowing money to fund this shortfall, as that will eat into profits and make the business unsustainable.

Unrealistic projections: Franchisers may overinflate the potential financial performance of the business. They may not account for the specific market that you are operating in. Different income groups will result in different profit margins. Not every location is worth the same amount.

Unfair contracts: Makhubele says many franchise agreements are heavily in favour of the franchiser. Any exit clause usually requires the franchisee to pay any outstanding franchise fees for the period of the agreement. The agreement also protects the franchiser from any liability in projected figures.

Funding your franchise

Makhubele says banks will most likely only finance 50% of the purchase price. The bank wants the franchisee to commit their own equity. She also advises that one apply for a business term loan rather than a personal loan, as it has lower interest rates.

If Sanet and Marius had taken out a business loan, their interest rate would have been capped at prime plus 10%. As they had taken a personal loan, the interest rate was far higher. The bank will also require that you do a formal business plan, which brings discipline into the process.

“Although we expect franchisees to have done their own homework and be certain about their investment, we will still do our own viability assessment,” says Makhubele, who uses a recent example in which a client applied for a R10 million loan to purchase a franchise.

We knew this store had been on the market for a long time and the area was in decline. It wasn’t worth what he was paying, and we declined the loan.

Being turned down for a loan is a warning sign to check your figures.

Assess the area: “A quick calculation of the income potential in the area versus the sales projections provided by the franchiser can reveal whether the figures are realistic or not,” says Absa national business development manager for fast-moving consumer goods and consumer services Abigail Makhubele, who advises accessing the local municipality’s Integrated Development Plan.

This will provide the different income segments and your potential target segment, so you can conservatively target the percentage of the population that will buy your products.

Speak to other franchisees: Any good franchiser will share the details of their franchisees and encourage you to meet with them.

Beware of “too good to be true” deals: Makhubele says you should be wary if the franchise is offering unrealistic returns or making unrealistic promises.

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