Raising Entrepreneurial Capital

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Raising Entrepreneurial Capital

• Chapter 9 Franchising

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Franchises are big business

• Franchises are very important to
  commerce--accounting for 45 percent of retail
  sales or 1.55 trillion in total revenue in 2010
• Franchises exist worldwide. Ten percent of retail
  in the United Kingdom, France and Australia is
  carried out in franchises.
• Source http//www.score.org/

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More on financial impact

• Franchise businesses accounted for 10.5 percent
  of sales of businesses with paid employees in
  2007. 
• Franchise businesses accounted for 153.7 billion
  in total payroll (about 10 of the amount for all
  businesses), and 7.9 million workers (about 13
  of the workforce).

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The successful franchisee

• Is somewhere between an entrepreneur and an
  employee.
• The hard work and drive associated with the
  entrepreneur are still needed for a successful
  franchise,
• but the typical franchisee neither needs, nor
  typically has, the vision and constant pursuit of
  new ideas typical of most entrepreneurs.

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The franchiser

• The originator of a business concept or product.
• An entrepreneur who chooses to grow by leasing
  his or her idea to others, the franchisees, to
  penetrate the market and expand geographically
  faster than would be possible for the franchiser
  to do on his or her own.

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The franchisee

• The operator, licensed to use the franchise name
  and operate under the rules and directives of the
  franchiser.
• The franchisee buys the right to use the
  franchise, typically for five to ten years.
• The agreement can be renewed but this arrangement
  provides protection to the franchiser against
  being saddled with a substandard franchisee.

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Product/trade name franchises

• Grant the right to sell a product or use a trade
  name. Franchisee functions essentially as a
  distributor.
• Independent business benefiting from
  franchise-wide marketing efforts and name
  recognition and reputation.
• Largely auto/truck dealers, soft drink bottlers
  and gasoline service stations.

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Business format franchise

• A complete business system.
• The franchisee acquires a proven business model,
  receives expert guidance and advice and usually
  has exclusive rights to a geographic territory.
• The franchiser realizes increased revenue and
  more rapid expansion than would be feasible
  otherwise.

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Franchise agreement

• Establishes standards for the business.
• Operating systems, technical expertise, hiring
  guidelines and management methods are provided,
  and procedures are specified.
• The franchiser provides marketing, and often
  products, supplies and services.
• Training is provided both at start-up and on an
  ongoing basis.

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Lowering the risk

• Brand name is well known and respected,
  positioning the entrepreneur in the marketplace.
  Think McDonalds, Starbucks, etc.
• If the franchise has an established track record,
  the franchisee is purchasing a proven business
  model.
• Franchiser often provides help with site
  selection, facility layout, vendors and
  financing.

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Failure rates

• While new business start-ups fail at a rate
  estimated in the 50 range during their first
  five years in business, the failure rate among
  new franchises is far lower.
• Some sources cite the failure rate as low as 5,
  but it is important to note that this is the
  failure of the franchise not the franchisee.

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Lowering operating costs

• Centralized functions that can achieve economies
  of scale are most efficiently carried out by the
  franchiser.
• Cost savings due to scale can be achieved, in
  purchasing and advertising for example, and
  passed on to the franchisee.
• Local site improvements are generally best
  carried out by the franchisee.

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Drawbacks to franchising

• The franchisee must share the wealth through
  royalties and other fees and expenses, typically
  3 to 6.
• The amount of time and effort devoted to
  launching and running the business is similar to
  any other entrepreneurial venture but the
  entrepreneur relinquishes a degree of control and
  independence to the franchiser.

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Costs to enter a franchise

• Vary dramatically by the type and market share of
  the franchise.
• Initial franchise fees, the cost to buy into the
  franchise, range from under 10,000 to hundreds
  of thousands.
• The average or typical initial franchise fee for
  a single unit is 20,000 to 35,000.

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Want to own a McDonalds?

• McDonalds charges a 45,000 franchise fee, this
  is only the initial fee for licensing rights.
• Other start-up costs include real estate,
  inventory, equipment, employee training, etc.
• Total cost to open a McDonalds is likely to be
  over 1 million.

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Financial requirements

• An initial down payment is required when you
  purchase a franchise outlet. For a major
  franchise this could be on the order of 300,00
  to 500,000
• The down payment must come from non-borrowed
  personal resources.
• Cash flow is likely to be tight in the first year
  or two and cash demands could push the franchise
  into unprofitability or worse.

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Due diligence and the FDD

• The Franchise Disclosure Document (FDD) is the
  format for disclosing franchisor information to
  prospective franchisees. It is required by the
  FTC.
• This document, which must be supplied by the
  franchiser, is essentially a prospectus
  describing the business and the opportunity.

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More due diligence

• Interview several current franchisees and as many
  as feasible of the ones who have left. Find out
  the reasons that those people leaving the system
  left.
• Ask current franchisees whether they would invest
  in this franchise if they had it to do over.
• Ask about profitability and time to break even
  for their franchise.

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Franchiser financing

• Many franchisers provide financial help in some
  way. Often it is through an established
  relationship with a lender.
• Frequent lender is familiar with the business
  model and the cash flow needs of the franchise at
  start up.
• Some franchisers provide financing themselves,
  and some obtain financing on behalf of the
  franchisee.

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SBA financing

• The U.S. Small Business Administration has been
  guaranteeing loans for franchisees since 1993.
• Franchisers may register with the SBA Franchise
  Registry. This is optional, and does not convey
  approval by the SBA, but is a mechanism to
  expedite financing.

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SBA financing advantages

• SBA loan guarantees can cover up to 85 of the
  loan amount. Loans are made for general purposes,
  including the franchise fee, and for real estate
  acquisition.
• The Franchise Registry provides a list of
  approved franchises http//www.franchiseregistry.
  com/registry/
• About 10 of all SBA loans go to franchisees,
  with the size running between 250,000 and
  500,000, and a maximum of 2 million.

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SBA terms

• The SBA prefers that the borrower have 30 of the
  franchise fee in cash before a loan is granted.
• The loan applicant must still comply with the
  SBAs requirements for experience, financial
  resources, character and capacity to repay.