Five Factors to Consider Before Expanding Your Franchise Footprint
Are you a successful franchisee beginning to weigh the pros and cons of expanding your empire? There are many good reasons to consider this, not least of which is that multi-unit franchisees can earn more by spreading their risk and achieving economies of scale.
That said, moving from a single franchise to a multi-franchise model is a big step, and one that shouldn’t be taken lightly. Before even considering a possible expansion, a sole franchisee should ask some basic questions:
Is this first unit working for me?
How is my unit performing within the franchise system?
How strong is my relationship with my franchisor?
Is it clear in which direction my franchisor is taking the brand?
Do I have the team in place to manage this transition?
It is often said that achieving success as a sole franchisee does not guarantee success with multiple units—and for good reason. A franchisee that tackles multiples franchises too soon can quickly become overwhelmed. Operating more than one franchise requires a different skill set as the franchisee moves from day-to-day operations to overseeing a portfolio of locations and their managers and other staff. Often, multi-unit franchisees underestimate the amount of personal time they need to dedicate to their growing footprint.
With so much to consider before taking the plunge into multiple units, it can be difficult for any franchisee to gain confidence that he has covered all the bases. CIT advises its franchisee customers to focus on five major factors to simplify their decision-making process: strength of the franchisor, business plan for growth, financing options, financing partner and exit strategy.
1. Strength of the Franchisor
One of the core prerequisites for pursuing the path toward multi-unit franchising is having a strong franchisor behind you who has a well-articulated growth plan that aligns with your objectives and a track record of supporting franchisees as they grow. Your franchisor may indeed have a plan for growth, for example, but not in the geographic area that interests you. It’s important to make sure your needs are in step with those of your franchisor, or you risk finding yourself out on your own as the franchisor focuses its efforts elsewhere.
Ideally, franchisors should have at least a three-year record of being in the franchising space. Be very careful when considering expanding into a multi-unit arrangement with companies who made their name with company-owned stores and are beginning to dabble in a franchising model. The trial may indeed pay off, but do you really want to bet your future on somebody else’s experiment? Supporting growth through a franchising model is very different than managing a network of company-owned units. For instance, franchisees need a different level of marketing support than company-owned stores. Those considering multi-unit ownership need to know that the franchisor is going to help get the word out when they open each new unit. To find out more about a company, speak with other multi-unit franchisees in the system about their recent experiences.
Those who have already been operating a single unit for a matter of months, if not years, should have a fairly good grasp of how much operational feedback the franchisor is providing. Best-in-class franchisors have mature reporting systems to provide their franchisees with financial and operational data that will allow you to benchmark your business against others in the system. These franchisors will also help multi-unit franchisees come up with solutions to any problems they encounter based on their experience addressing mistakes made by other franchisees. Detailed reporting and feedback will be critical to ensuring that your success with one unit translates to multiple units.
Finally, be sure your franchisor is on sound financial footing before doubling down on your investment. The franchise disclosure document will provide much of what one needs to know about the health at the top of the house, including franchise failure rates.
2. Business Plan for Growth
No franchisee should consider expanding beyond a single unit until she has at least six months of showing a profit and has worked out all of the day-to-day operational issues. Tacked on to a typical two to six months spent getting up and running, that means the average sole franchisee will have at least a year of operating experience before exploring a possible expansion. The path to profitability will vary greatly depending on the industry sector of operation. For example, a hotel can take up to a year to become cash flow positive, while a day care operation can take as long as 18 months.
During this time, one has learned a lot about the business: how long it took to become cash flow positive, how much capital it required, what unexpected challenges arose, and what potential headaches to avoid. Now it’s time to take this information and plug it into a financial model for the next go-round.
Find someone on your staff or in your support network who is financially savvy and “stress test” your plan for adding a second unit. Pay particular attention to the timing assumptions made. Is it really feasible to add another unit every six months, or should they be spread it out over a couple of years? How much working capital must be set aside for the start-up phase, and are there enough resources if that phase stretches beyond six months?
It is important to be honest with yourself about whether you will be able to draw enough salary to cover your lifestyle and pay additional management staff to assist with your planned growth. Every time a new unit opens, be prepared to reinvest in your business. This can be a high hurdle for those who have grown accustomed to a certain level of cash flow and standard of living.
3. Financing Options
Before the credit crisis, franchisees could turn to any number of financing options to fund their growth. Banks and other conventional lenders were fairly active in the space. Credit card advances and loans against 401(k) assets or home equity were viable alternatives. And, if all else failed, family members might be able to come through. Now, with the pullback in credit and declines in stock values and real estate markets, most of those channels have either closed or tightened significantly, particularly in the franchise finance market of $5 million or less.
Best-in-class franchisors have mature reporting systems to provide their franchisees with financial and operational data.
One holdout from this fallout is the Small Business Administration. Franchisees can obtain financing up to $5 million for as much as 80 percent of their needs, spread out over 10 years (or 25 years if real estate is included). Another advantage of SBA loans is that the rates it can charge are capped at 275 basis points over the floating prime rate.
Franchisees need to know going in that most SBA lenders are going to look for assurance that the borrower has enough capital to inject into the project. In most cases, this will mean 20 percent of the total start-up costs or about $100,000 for a typical $500,000 franchise unit. Some lenders may require more than that depending on the borrower’s credit profile and a lack of experience lending to that particular franchisor.
While some of the other options may return as the economy and credit markets continue to recover, SBA financing will likely remain a preferred financing vehicle for franchisees for the foreseeable future.
4. Financing Partner
There is a particular pace to the relationship between franchisors and franchisees, and lenders with franchise financing experience know where they fit in and how they can support the business. As a franchisee, look for a financing partner who has worked broadly in the franchising space across a number of concepts and is familiar with the various ups and downs of different industries. Lenders with specific experience in your particular industry or your specific brand will have a much better understanding of what it takes to succeed in your business and will therefore deliver better service.
5. Exit Strategy
Franchisees always need to keep the end game in mind. At some point, they are going want to scale back and focus on enjoying the fruits of their labor. It’s never too early to start planning for this eventuality.
As a multi-franchise operator, there will be more cash flow than before and your business will be a bigger pill for someone else to swallow. It may be advantageous to sell one unit at a time, rather than all of them as a group, particularly if one is winding down over a period of time.
Understanding the range of multiples that franchises in your system and your specific area have demanded will help set the right expectations when it does come time to sell. Based on those prices, calculate whether there will be enough cash on hand to step away from the business at that time, factoring in how much debt you will have retired by then.
In the franchising world, one can’t eliminate surprises—but if one puts the work in, surprises can be limited. Budding multi-unit franchisees who take the time to explore each of these factors and align their expectations and plans accordingly will relegate these surprises to the realm of contingencies as they grow their business—and prosper along with it.
Todd Harrington is chief sales officer of CIT Bank – Small Business Lending, a leading Small Business Administration 7(a) volume lender. He can be reached at 973-422-6103 or Todd.Harrington@cit.com.