How to Assess Franchise Profitability
Probably the first question that passes any business prospector’s lips is: How much money can I make in this business? Arriving at a true answer, however, may not be as easy as it seems.
For starters, the question entails lots of unknown variables. First, as everyone knows, different people perform better with different models, depending on their skills, experience, and personalities. Some people, for example, are simply better able to adapt to changing circumstances and know how to take advantage of opportunities as they arise.
Second, and even more important, it takes time to get your business to profitability. How long varies, depending on internal, as well as external factors. One type of business might become profitable in just a month or two, while others can take several months. Getting to maximum profitability may take considerably longer, since the business will usually grow as you go along and gain knowledge and expertise. As I’ve mentioned, one of the biggest advantages to buying a franchise is that you can talk to franchisees, who can give you a good sense of how long a particular business takes to become profitable and how much profit you can eventually expect to make.
A good franchise system can show you how to bounce back from the rough spells and flourish every step along the way, from the first day through every evolutionary change in your industry. As we have emphasized, assessing whether your unique bundle of skills and experiences provides a good match for a specific business is a key part of your research.
Assuming you find a perfect franchise for your skill set, you like the executive team, you determine they have great training and support systems, and it’s a business in which you can thrive, how much profit is enough?
To answer this important question, first you need to pose a set of basic questions to determine your own personal bottom line.
The Top Questions New Entrepreneurs Need to Ask Themselves
1. How Do I Balance Quality of Life with Earnings?
As you start to look around for a business to buy, you’re likely thinking
about the best ways to balance your life with your career. The good news is that with a franchise, you can find both high profit and work-life balance, whether that means flexible hours, fewer hours or the ability to work from home.
In the wide world of franchising, there is a category of franchise that requires fewer hours from the owner called semi-absentee. These businesses are set up to rely on a manager to run the business. The owner then manages the manager. Many semi-absentee businesses require only 10 to 15 hours per week from the owner, which makes them perfect for somebody looking for additional income while continuing with a job in the corporate world. This category can also suit the needs of someone looking to retire, yet not ready to stop working altogether.
2. Am I looking For a Six-Figure Income?
Almost every client I’ve ever had was looking for six figures, and some well into six figures. This is eminently possible with a franchise. But not all franchises will get you there. With the experience of a good franchise coach, plus a thorough due diligence process of your own that includes interviewing franchisees, you can get a good idea of what a franchisee can earn.
Of course, earnings will vary by owner. Some people are just better at running the business than others. Another point is some business types are not ever likely to earn more than five figures. If you plan and research correctly, however, there is no reason you can’t pinpoint a business that has the potential to provide you the living you want.
3. Do I Want to Operate a Single-Unit or Multi-Unit Operation?
Many franchise companies allow you to earn well into the six figures with a single unit, but with other franchises, a six-figure income results from operating multiple units. In these franchises, each location is run by a hired manager, which allows you to acquire and operate several sites.
These franchises can be extremely lucrative. If you see yourself owning multiple locations and you’re willing to accept that your earnings will only build to their highest level as you open your second or third, then this type of franchise might be a good fit for you. Many people do extraordinarily well with large numbers of locations. Of course, by then you will have developed a crack administrative team to help you manage them all.
4. How Much Money Do I Need to Get Going?
When you embark on a new business venture, let me reiterate, the single most important question to ask yourself is: How much capital will I need? Even with the best idea in the world, if you can’t keep your business going while you get all your systems up and running, you’ll go under.
In short, you need capital to get you through the start-up phase.
Virtually the only business model where you can definitively answer the question, “How much money do I need?” is a franchise, whose systems and capital requirements have been tested by dozens of franchisees.
You can find out how much it costs to start up and operate in the franchise company’s Financial Disclosure Document (FDD), which all franchisors are required by federal law to provide to potential franchisees.
Besides learning all your upfront costs ahead of time, you can and should learn about potential costs by interviewing franchisees. Don’t forget to factor in differences based on geography and the range of talents and skills of individual franchisees.
Even armed with the knowledge about how much it will cost to run your business, you should figure out how much money you need to live on until your business starts generating income.
Some franchise companies will disclose earnings estimates, but you should always double and triple-check these numbers with franchisees. A realistic, even conservative, estimate is essential. Your success may depend on it.
3 Keys to Understanding Your Potential Franchise Earnings
Know Your Timetable
Most businesses take at least a couple of months to start earning a profit. The slowest to become profitable are franchises that take longer to build a customer base. If the margins are thinner, you need to generate more volume.
Accurately Estimate Your Start-Up Costs
The FDD provides a list of all your start-up costs, which are far more extensive than just the initial franchise fee. Item 7 gives you the actual numbers for costs and includes signage, office furniture, equipment, leases and security deposits, licenses and permits.
Estimate Potential Income
Flip now to Item 19 of the FDD to read if the franchisor has made any earnings claims. Only about one-third of franchisors make earnings claims, and how franchise companies address this issue varies.
To fill out the picture, you will need to call as many franchisees as it takes to learn reliable answers to your questions, preferably those operating in locations like yours, to verify all the information in the FDD and get an idea on profits. Word to the wise, avoid the question: How much money do you earn? Instead, try a softer approach, such as: “How long until I can expect to make $100,000?” Then try out different numbers.
Financing a Franchise
Your top priority must be ensuring you have enough money to start and run your business until you begin to earn a profit.
As we have emphasized, by the time you invest capital into your new business, you should know from your research and preparation exactly how much money you will need, and you should be certain that the business you select matches your skills, experience and interest.
Many lending options are available to finance new franchise businesses, even though most are purchased by people who have never run a business before and usually are new to the particular business. The reason: Franchises offer a proven model for earning profits.
Most franchisees put together a package that may include:
- A loan from the US Small Business Association (SBA)
- Traditional savings
- Home equity loan
- Tapping into a 401K or IRA
While using retirement funds to help you start a new business should not be undertaken lightly, the procedure, called Rollover as Business Startups, has many advantages, according to Sherri Seiber, chief operating officer of FranFund Inc., a Fort Worth, Tex.-based firm that has advised thousands of franchisees on funding their new businesses.
This technique, nicknamed ROBS by FranFund, allows you to self-fund your new business by using your retirement funds, pay no tax on the funds you use, and save the costs associated with a loan.
Seiber, who jokes about the ironic acronym, said the Employee Retirement Income Security Act of 1974 allows people to roll over a portion or all of their 401K or IRA (not Roth IRA) into a new 401K profit-sharing plan sponsored by your new corporation or business entity, which buys stock in the new corporation without penalty or paying additional tax.
The 401K becomes a stockholder in the new business. The operating account of this new corporation can be used for any legitimate business expense, including paying yourself a salary during the start-up phase before you begin generating revenue.
Instead of your 401K buying stock or mutual funds, you use your retirement savings to invest in your business. If the value of your business increases, so does your retirement account. Likewise, if, in the worst-case scenario, your business fails, you lose your money, but you won’t have tax liabilities and penalties. And unlike traditional loans, you wouldn’t be putting collateral, such as a house, at risk.
ROBS had been a top way businesses under $150,000 to $200,000 got funded a few years back, Seiber said. “Back then, 65 percent to 70 percent of our clients used that method alone or in conjunction with another loan.”
But as credit has loosened up as we get further past the Great Recession, Seiber noted, only about 55 percent of their clients use ROBS to finance their businesses, and many are combined with a loan.
Some people use ROBS as a way to inject equity into a loan application.
The main caveat is that you could lose your retirement savings, and as Seiber notes, if you don’t believe you can be successful in your new business, this path is probably not for you—and, of course, you may not want to go into that business at all.
If you don’t want to touch your retirement account, bank lending can be a good alternative, particularly as lending markets have opened up after years of limited activity following the Great Recession.
“We have a group of lenders who like franchises,” Seiber said, and FranFund can often get people with good credit through the approval process in under five days.
FranFund’s specialty is putting together a complete package that can move quickly through the process for a “fast and reliable yes.”
Many firms offer ways to prequalify people for loans, which can help speed up the application.
There is one final question you have to ask yourself:
Do you really believe you have what it takes, meaning skills, experience, and work ethic, to to make a success of your new franchise business?
If the answer is yes, then you can feel comfortable investing in yourself.
This blog sourced from and accredited to Dan Citrenbaum, Author of Own Success;
Permission granted by Dan Citrenbaum.