No pain, no gain in the franchise phenomenon

FOR SOME of the newly unemployed, escaping the corporate rat race and setting up on their own seems a tempting proposition. Yet starting up an entirely new business can be a daunting affair, leading many to consider the franchise of an established brand. While all businesses are suffering in the current environment, some franchises, such as McDonald's, which is adding three new restaurants to its Irish chain this year, are still going strong, writes FIONA REDDAN

Franchises have boomed over the past decade, with latest figures indicating that turnover is in excess of €2 billion, with more than 270 franchises employing in excess of 25,000 people. Indeed, everywhere you go in Ireland, new outlets of the same brands are popping up.

The essentials of a franchise agreement is that for an initial fee, as well as an ongoing licensing charge, a franchisee will acquire the rights to market a product or service using the trademark of another business.

The major advantage of a franchise is that it can minimise the risk of setting up a new business, as you will be selling an established brand and can avail of support services such as training and business advice from the franchiser, as well as sharing in marketing costs.

“The chances of still being in business for a regular start-up after two years is 55 per cent, while for a franchise it is 95 per cent,” says Tony Fitzpatrick, managing partner of Franchiseyourbusiness.ie and a member of the executive board of the Irish Franchise Association.

Moreover, while potential franchisees are expected to have significant personal resources to invest in the brand, the upside is that banks are more willing to lend to franchises than to traditional start-ups. Banks tend to look more kindly on franchises given the lower failure rates, while the brand will already have a proven track record, often in the Irish market, which makes them a much more attractive lending prospect.

However, while attractive, franchises are far from being a “sure thing”, and things may go wrong, as franchisees of the O’Brien’s sandwich chain have learnt. When the company got into trouble earlier this year, with debts of more than €4 million, franchisees stopped paying their royalty fee, and the franchise has subsequently gone into examinership.

An unusual set-up, O’Brien’s, which has 85 franchised outlets in Ireland and a further 135 around the world, holds the leases for most stores and then sub-lets to franchisees. Given the deteriorating economic environment which led to a fall-off in demand for its products, franchisees were finding it difficult to meet the high rents, many of which O’Brien’s had leased at the height of the property market.

Normally, franchisers leave it to franchisees to find and rent their own properties, but the decision by O’Brien’s to lease all the properties left it particularly vulnerable to the downturn. Now the future outlook for the franchises is uncertain, and although the franchisees themselves are not subject to the examinership, if the company cannot trade out of its current difficulties or find additional investment, then the brand may dissolve, bringing the individual outlets with it.

Other franchises have also run into problems, such as the UK chain Coffee Republic, which has gone into administration due to a fall-off in sales, while in Northern Ireland, the company which holds the Pizza Hut franchise for the region also went into administration.

While it is impossible to predict the future for a franchise, Fitzpatrick says that a good starting point for potential franchisees is to check the franchisers’ accounts before committing, to ensure that the chain is profitable. “You need to ask yourself does the franchiser have the financial capability to promote the brand, and are they in it for the long-term. You should look for a franchise that has proven itself and has been in business ideally for two years or more,” he advises.

Given the extra expense involved in acquiring a franchise, picking the right one is essential, as if things go wrong, you will be liable for any debts you have incurred. According to Bank of Ireland, start-up costs for a franchise run at between €2,000 to €500,000. On average, it takes five years for franchisees to see a return on their investment, so if the franchise fails before this, the franchisee will be stuck with the debts they incurred acquiring the business.

At O’Brien’s, a franchise does not come cheap. In addition to a licence fee of €9,000, which gives you the right to use the brand and associated products, a franchise package fee of €16,000, which includes training and launch promotion, is also charged. On top of this, franchisees are expected to raise finance to pay for fixtures and fittings for the outlets, which cost from €95,000 to €190,000, while other costs including furniture, franchise fees and working capital bring total set-up costs for an O’Brien’s outlet up to between €246,500 and €388,500.

In addition to the initial costs, franchisees are also faced with ongoing costs, such as a regular monthly or annual fixed payment back to the franchiser, which is usually about €1,000 a month, while franchisees must also contribute to the cost of advertising the brand. For example, the marketing fee at McDonald’s is 3.75 per cent of sales. In addition, franchisees are expected to contribute royalty fees to the franchiser, which generally run at about 7 per cent of turnover. When O’Brien’s stopped receiving such payments from its franchisees, its difficulties were compounded.

Generally, franchisees are expected to come up with about 30 per cent of the set-up costs, with a bank loan covering the rest, so it would have taken between about €81,345 and €128,205 to establish an O’Brien’s outlet. Given the current environment, banks’ willingness to lend to franchises has decreased in line with other sectors, and this is another difficulty potential franchisees will face.

“Before the credit crunch, banks used to lend about two-thirds of the start-up costs, with the franchisee contributing one-third. More recently, the criteria has changed, and is now probably about 50/50,” says Fitzpatrick.

And even if you have the money, it doesn’t mean that the brand will accept you as a franchisee. For example McDonald’s has a number of strict requirements and it describes its selection process as “rigorous”. It looks for applicants with a “demonstrated ability to lead and manage people, good common business sense and a track record of success in whatever they are doing”. And, in addition to committing to spend a year – unpaid – learning all aspects of running a McDonald’s restaurant, franchisees must also give up other active business interests.

If a franchise is still for you, there is currently a wide variety of companies looking for franchisees to build on their brand and expand further into the Irish market, with options from everything from restaurants, coffee shops, cleaning firms, female gyms and business coaching available.

And, if you’re brave enough and confident in Nama cleaning up the property market, it is also possible to franchise an estate agency. However, you might be waiting some time to make your first royalty payment.