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A good mule will do that, you know. What? I said, a good mule will do that. Do what? Tote the load. That's what. What're you guys talking about? Y'all had a few too many? Is it time for me to cut y'all off? No, it ain't time to cut us off. We're talking about totin' a load in a non-farm context. Leroy here says he wants to franchise his business, and we've been discussing some shorthand way to tell if a business can be franchised.
Lotsa folks say any business can be franchised. We think that might not be so. While a concept may be franchisable, we don't think every business in that concept can be franchised. It don't matter that folks like it and ask you about whether you ever thought of franchising it. And it don't matter, at least in the final analysis, that Jethro and Homer are out there with 300 franchisees in the same business. Even if all them questions and comparisons are 'yes' answers to your 'Can I franchise this?' question, there is the final 'mule totin' issue. A good mule can tote the load. A sorry mule won't.
The 'load' is the total financial burden that the franchised business has to carry and still yield an acceptable income to the franchisee. We've seen many franchise opportunities fail where someone else is successfully franchising the same business. The difference is part management style, part marketing, but, in the end, load toting.
Not every small business grosses a couple million bucks a year. Most franchised businesses are lucky to gross between $500,000 and $1,000,000 a year. Some folks don't believe that any business should be franchised that grosses less than $500,000. Profit can be affected by how the business owner decides to write off his capital asset investment and by how the owner decides to configure owner compensation. Of course there is the issue of some personal expenses finding their way into the business ledgers too. But, in the normal course you start with the federal tax returns. Nobody overstates their profitability on their tax returns. So that is the acid test.
If a non-franchised business grosses $500,000 and nets 20% of sales (often an optimistic percentage), and you want to franchise it and add 6% royalties and 2% advertising fund payments, that net decreases to 12%. If the net were 18% pre-franchise, it would decline to 10%. If owner's compensation has to come out of that (as in a Sub-Chapter S situation), owner's compensation would go from your well-managed $100,000 per year (pre tax) to $60,000 (pre tax). That makes the franchisor more than a 40% 'partner' in the net revenue, but without any partner's risk. You could add to that bottom line the non-cash charges for depreciation and amortization, but that money is most frequently used for debt service, and doesn't represent money to the owner.
If we assume the owner made a salary before buying the franchise sufficient to enable accumulating net assets to fund the total initial investment to buy and establish the franchised business, there may well be no annual income improvement resulting from the investment in the franchise. All the business about 'equity' is frequently more puffing than substance. The most important attribute of equity is that it is at risk, every day.
In this scenario, any diminution in revenue produced a negative absolute answer to the question 'Should I invest in this?' Actually, if the best scenario is that there is not a very substantial improvement in owner's compensation compared to what the owner was doing before buying the franchise, the answer to the investment question is still a negative.
So, if you take the tax returns of the owner of the business to be franchised, and you subtract from that net profit the burdens to be put upon franchisees, you can come to an understanding of revenue credibility in the franchising context. No matter how great the concept is and how much hype you can interject into marketing, revenue credibility is the final, indispensable answer that must be affirmative.
There are other variables that can be applied. Things like time taken to achieve break even and having to buy supplies from sources that don't have to compete for the business because they are the only designated supplier, could be factored into investment return equations. You can make it very complex simply by throwing in more dependant variables.
Maybe the answer is that folks who buy franchises aren't sophisticated enough to do this kind of analysis as part of their investment decision. If one looks at franchise failure rate history, that lack of analytical sophistication seems like a real issue. But you can ask yourself whether, after taking out royalties and advertising, and subtracting what the potential franchisee can make in his job (or in another job for which they might be eligible), there is enough net profit to provide a return on the total initial investment sufficiently superior to a savings account or money market return to justify the investment risk. If the answer is 'Yes', then maybe that mule can tote. That's what 'Revenue Credible' means.
Copyright 1997 - 2008 || Richard A. Solomon
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 | Licensing, Technology Transfers, |