Understanding the Numbers with Ethel Nyembe

What financial numbers you need to take into consideration with becoming a franchisee.

Understanding the Numbers with Ethel Nyembe

How does the franchisor spend my fees?

If franchisors are good at what they’re doing and run a good operation, they will spend your fees to provide support to you, for example field agents who help you when your business is getting into trouble or can teach you the new best practices. It may be that they’re assisting with bulk buying, distribution or central logistics that are helping your business.

However, there are some franchisors out there who don’t run a very good operation and generally don’t last very long in the industry. They might be taking your fees and not spending them in the right way. Be very careful of these operators.

– Ethel Nyembe

What are the hidden costs that are often not considered?

Hidden costs that might crop up are in areas like revamps. Revamps are timed and you’ll have to engage in them on a five year basis or as stipulated in your franchise contract. These could be costly and they could occur when you don’t have free cash flow.

It’s important to talk to existing franchisees and ask them what their hidden costs were, because only once you’re in the system do you understand what they might be. Get a feel for what types of fees are being asked and their frequency.

— Ethel Nyembe

What are the pros and cons of cheaper versus more expensive fees?

It’s not about how cheap or expensive fees are, but what they’re being used for and their return on investment. If you’re being charged 5% of turnover for your royalty fee, you need to be in a position where you feel you are getting that value back from the franchisor. Ask existing franchisees whether they feel they’re getting value for money for what they’re paying.

It’s difficult to tell on a percentage basis whether one franchisor is asking too much compared to another. From system to system or brand to brand lower fees might mean lower support, and less profitable businesses, or vice versa. Do your homework and evaluate all your options.

— Ethel Nyembe

Is there any formula that determines if the price of a franchise matches the value one receives?

The different sectors in the franchise industry have certain norms by which they charge upfront fees, capital expenses and franchise fees.

In the retail industry for example, it’s sometimes five times the average monthly turnover; in the quick service restaurant industry it is often twice the annual profit and in the fuel sector it can sometimes be 13 times the earnings before tax.

Franchisors have their own industry norms. A very popular formula to use is called the ‘owner benefits formula’, which is profits plus salary plus any non-cash expenditure multiplied by anything from one to three, depending on the strength of the franchise or the going concern. Keep in mind that there is a direct correlation between the going concern and brand recognition. A well-recognised brand will have higher goodwill attached to it.

— Elana Koral

If I buy a new franchise, how can I be assured the budgeting and forecasts for the outlet will be accurate?

You have to look quite deeply into the numbers from an auditing perspective. The franchisee should review the disclosure document, which is quite detailed in terms of the requirements from the franchise association.

This should give the franchisee an idea of the historical track record as well as projections of the brand. Again, you cannot rely solely on this. Do your own research, which includes speaking to existing franchisees, including good ones, bad ones, and even past franchisee. Don’t just rely on the franchisor to give you all the answers. Do your homework.

– Elana Koral


What is typically included in a good franchising system when it comes to training?

You must differentiate between the training of hard skills and the training of soft skills. Many franchisors focus on the hard skills, which are the technical aspects of running the business. However, the soft skills are just as important, such as gross margins, how to calculate financials, work out customer patterns, customer marketing and so on, including anything that will affect the business in its totality.

The training often takes the form of classroom training, where new franchisees and their staff may attend three days of classroom training and/or job training, which is imperative in a good franchise system.

Training gives you the opportunity to get a real taste for what the franchise is about. In terms of staff training, employees can be trained by the franchisor in some cases. Sometimes franchisors give the franchisee a template by which to train their staff and other times it’s left entirely to the franchisee. Again, the level of franchisor involvement depends on upfront fees and what the franchisee pays for the services.

– Elana Koral 

Researching the franchisor

What are the key criteria one should use to evaluate one brand over another?

When you’re looking at franchising brands, it really depends on what kind of sector within franchising you want to go into. You then need to look at various franchising brands within that sector.

This is often related to how much you have to spend on a franchise. You might have very little or a lot of money you want to invest and that will determine to a larger extent which brands you can look at.

The next step is to determine which brands operate well. Ask franchisees how they experience franchisor support and what it’s like to be in that system. You’ll get a feel for which brands are better than others. Often it’s a matter of personal taste and a cultural fit that you’ll find within a particular brand.

– Ethel Nyembe

Is it better to buy a new or existing franchised unit?

When buying an existing franchise, there are dangers but also a lot of pros. An existing franchise gives you the perspective that you have a proven track record, there’s an existing customer base, you understand how that particular market operates and you can say this is how much a particular franchise makes in that area.

The downside of buying an existing franchise would be that you would inherit the staff that the previous owner employed. You would also have to inherit the existing legacy systems. There could be stock or point of sale systems that don’t meet your standards or requirements and you’d be buying all of that. Another con would be that some of the equipment may be old and the franchise itself may need a revamp.

– Ethel Nyembe

How do franchisors make their money?

The management services fee is generally a percentage of turnover of the franchisee’s store on a monthly basis. This may vary from 4% to 12%, depending on the profit quantums that the franchise generates. Again, the critical mass of franchisees is important, because if the franchisor is only getting 5% of turnover from a meagre ten franchisees, this will not be enough to sustain a franchisor.

Franchisors can also charge an advertising levy or marketing fee. This fee should be separate from the franchise levy and it should be very clearly shown in a statement how the fee was arrived at. The franchisor will often expect the franchisee to set aside a certain amount of money to pay for their own local area marketing every month as well.

What are the common stumbling blocks experienced by new franchisors?

The first mistake prospective franchisors make is that they think this is an easy way to raise money for the business. Franchising a business is not a quick, easy or cheap way to grow.

There are a lot of costs that will be incurred during the franchising process, including getting consultants on board to help make sure the business is franchisable and help develop expansion plans, research and development costs, legal fees, the costs of setting up a pilot company-owned operation (if this hasn’t already been done) and the cost of marketing the new brand.

The last point is particularly important – there needs to be a strong marketing fund to build the brand because the brand is the essence of the entire franchise operation. So be sure to evaluate how old and how experienced your prospective franchisor is.

– Elana Koral

What is the best way to conduct a due diligence on a brand and its executives?

There are two ways of going it: Qualitative and quantitative research. By quantitative we mean that you should look at when the business will reach break-even point, how much salaries are, what the owner’s drawings are, and what the expected gross margins are.

In addition, has the franchisor ever been convicted of any offence and has the franchisor got a good disclosure document which is copious and complete in its disclosures?

Qualitatively, one should also look at interviewing and meeting franchisees, including past and present franchisees. Ask past franchisees why they left the system, and existing franchisees how they find the franchise. Get as much feedback as possible from them.

In addition, do secondary market research such as website analysis on the company and look at franchising industry reports. There are many ways to analyse and investigate a company in terms of its due diligence.

Then, if it’s a new look at the upfront fee and ongoing fees, and if it’s a going concern look at goodwill, branding and customer patterns, and what the store has achieved in its historical patterns.

– Elana Koral

What are the pros and cons of investing in a ‘new’ or ‘young’ brand?

A new brand is great in that you’re starting off on a clean slate. It’s an unsaturated market, it’s brand new, you can develop your store from scratch and you’ve got the franchisor’s sole attention right from the outset, as they don’t have a new network to contend with.

The downside, of course, is that the very benefit of a franchise is having that tried and tested formula. Franchisors often sell the franchise based on their systems, which are developed according to historical patterns, customer patterns, and issues they have had experience with in terms of the business development.

– Elana Koral

What are the tell-tale signs of a fly-by-night operator?

If something sounds too good to be true, it normally is. And that’s the case with fly-by-night operators. Any business that seems unsustainable, a fad or a gimmick is not something you should look at. Fad products are not something that will offer a franchisee long-term growth.

Do a careful due diligence of the business, interview current and past franchisees, and get the disclosure document and franchise agreement from the franchisor. Ensure these documents are properly done and thought-through by the franchisor. If you aren’t sure, ask an expert for advice.

– Elana Koral

Standard Bank
About the Author
Standard Bank SA is the largest operating entity of Standard Bank Group, Africa’s largest bank by assets. Standard Bank SA provides the full spectrum of financial services, with more than 720 branches and over 7 100 ATMs. Independent surveys of customer satisfaction consistently place Standard Bank at or near the top of their rankings. The personal and business banking unit offers banking and other financial services to individuals and small-to-medium enterprises. For further information, go to http://www.standardbank.co.za

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