Evaluating what type of franchise is best for you

People looking to buy a franchise for the first time need to make a number of significant decisions about what franchise best suits them. Rod Nuttall , the National Executive Manager, Franchising, at the Commonwealth Bank, reviews a number of the factors that need to be considered -particularly in relation to buying a new or an existing franchise.

FIRST-TIME FRANCHISEES have to make a number of significant decisions that will have an impact on the business they will eventually run. These can concern everything from financing to business logistics and personal interests, but will always involve deciding what type of franchising system and business to buy into.

One of the major decisions to be made is whether to buy a pre-existing outlet that has a proven track record, or to start afresh with a completely new store. There are pros and cons to each option and prospective franchisees should consider these carefully before making a final decision.

How do the set-up costs compare?

Existing outlet: Buyers may be able to save on the initial outlay, but because equipment and shop fittings are unlikely to be brand new, they may need to factor in maintenance and replacement costs. It is important to investigate the condition of the store and its equipment prior to purchase and make budget allowances for upgrades and renovations if required.

New outlet: The cost outlay will vary depending on the system model and the size of the outlet, but for a new franchise, additional budget should be set aside to cover establishment costs such as construction, store fit-out, equipment and local area marketing.

Which provides a better return on investment?

There is little evidence to suggest that buying an existing store will generate a better return on investment than a new outlet.

Existing outlet: This may appear lower risk as it is an already established business with existing performance indicators and regular clientele. However, even a site that has been profitable is not a guaranteed success for future owners – this is dependent on the hard work and attention of the owner.

New outlet: Although it may appear higher risk and will require a lot more work up-front to raise the profile of the business, there are benefits. A new site is a clean slate and owners won’t have any hangovers from the previous owner’s choices, mistakes or reputation.

Which option is preferable for a bank?

Existing outlet: A bank may consider an existing franchise less risky because there are pre-existing business performance indicators to consider. It is important to gather all historical sales information when approaching a bank – these will be considered when evaluating eligibility for a loan.

New outlet: As there is no existing performance history to assess, franchisees seeking funding for a new site must undertake thorough research and develop a detailed business plan before approaching a bank. The more they understand the business and its realistic potential, the more likely they are to receive financing.

Will exit plans differ between a new and existing franchise?

Existing outlet: Buyers looking at a franchise as a short-term investment with an exit planned within five to ten years may be better suited to an existing franchise.

New outlet: Building a successful and sustainable business will not be achieved overnight – it will take time and effort. However, developing an exit plan to include how and when to sell the business will shape business goals and help ensure that returns are maximised.

What is a franchisor looking for?

Franchisors have a brand to protect and as a result, franchisees buying into any system – in new or existing locations – will need to be prepared for a rigorous selection and training process.

What about lease considerations?

Buyers of new and existing outlets should aim for their leases to run for the same period as their franchise agreements. When granting finance, a bank will base the maximum loan term on the length of the franchise agreement and lease. Without either of these, the franchisee does not have a business and as such cannot generate the required cash flow to repay the debt.

How does the status (size, reputation, financial status, number of sites) of a franchisor impact a franchisee applying for a loan?

The Commonwealth Bank has an accreditation process for franchisors that reviews elements such as the financial track record, number of sites, infrastructure and the overall size of the franchisor's system. Loan applications from franchisees hoping to be part of one of these accredited, established systems represent less financial risk to the Bank, due to the strength of the brand – and the processes, business models and support programs which underpin the success of the system – that they are buying into.

However, being a franchisee in an accredited franchise system is no guarantee of a successful loan application. There are a number of other factors that the Bank will consider including thorough business planning and sustainable cash flow projections.

While franchisees in an accredited system will more easily be able to demonstrate eligibility for a business loan, franchisees in a non-accredited system can also successfully apply for finance by fulfilling key elements of the Bank’s approval criteria, including adequate assets to back against the loan, and providing a thorough business plan.