The Dollars and Sense of Starting a Retail Franchise
Rick Chittley-Young, Partner
BDO Dunwoody
Marco stopped by to see me a while back for a chat. He wanted to pick my brains about a retail franchise he was thinking of buying. Marco’s a baby boomer who retired early and is looking for a new challenge. But he doesn’t want to jeopardize his financial security on a business that’s too risky. He thought this retail opportunity sounded right, especially because it was part of a franchise group that had been in business for some years.
While Marco had already undertaken some solid groundwork prior to our meeting, as we got to talking, he realized that there were a number of important issues that he had yet to consider. For others who may be contemplating the purchase of a retail franchise, the five areas we covered during our chat may be helpful as you assess the financial viability of a retail opportunity.
- Choose an experienced franchisor
- Research your marker
- Plan for sufficient funds to get started safely
- Write a business plan
- Set up a financial management system to succeed
These five steps will help to ensure that not only can you start your dream retail business, but you can also succeed with it in the long term.
1. Choose an experienced franchisor
According to Statistics Canada, between the years 2000 and 2004, the retail sector in Canada grew by 4.5% – exceeding the growth of other key sectors. There are over 200,000 stores in this country, indicating that retail is a popular form of business.
It’s also a competitive form of business. The retail sector has evolved dramatically in recent years. In just over a decade, Kresge, Kmart, Simpson’s and Eaton’s disappeared. The Wal-Mart juggernaut crossed the border by acquiring 122 Woolco stores and everyday low pricing, “big box” stores, warehouse clubs and superstores arrived. Today, franchise and independent retailers alike face formidable competition.
Yet within this environment there are many retail franchise successes. In fact, it’s estimated that franchises accounted for $90 billion in Canadian retail sales in 2002. (Canadian Franchise Directory)
The secret to being one of the retailers who thrives is allying with an experienced franchisor that knows how to compete in today’s retail environment and has a track record of doing so effectively. You don’t want to have to take on the retail behemoths with your own franchise – you want your franchisor to do so on your behalf – successfully.
2. Research your market
At the same time, you can’t rely on the franchisor to do all of your due diligence for you – you have to know your own market and opportunities. Retail stores have a high failure rate and the principal causes are undercapitalization, which we’ll address later, poor site location, and poor market analysis.
It’s the familiar rhyme: location, location, location. A bad location almost guarantees failure; a good location – success. Thorough research is essential to ensure that you are in the right location to attract prospective customers. Wisely, Marco had already undertaken extensive research about the proposed location for the franchise he was considering. Here are some of the factors to keep in mind.
- Check population statistics, demographics, and neighbourhood characteristics to determine whether the location offers a sufficient pool of prospective customers.
- Identify the location of competition and assess the compatibility of nearby retailers. Consider whether nearby businesses will help to generate – or hinder – traffic for your store.
- Evaluate visibility and accessibility – whether customers will be able to see and access the location easily. Consider public transportation routes and parking.
- Determine zoning restrictions and development plans for the area to find out if there may be restrictions that will limit your operations.
Identify and investigate merchants associations or BIAs (business improvement associations) in the area. A strong association can provide numerous benefits to local retailers, including group promotional activities and security measures.
3. Plan for sufficient funds to get started safely
Once you have the right franchise system and the right location, the next most important determinant of success is money – enough of it.
Undercapitalization is a very common cause of business failure. Most new business owners underestimate the amount of capital they will need to get up and running. Many focus on start-up and operating costs, but overlook funds to cover monthly operating expenses and personal expenses. You need to have a reserve to cover these requirements until your franchise starts to turn a profit. Here’s a summary of the funds you’ll likely need.
Franchise fee: for retailers, this generally ranges between $25,000 and $50,000.
Pre-opening expenses: these may include leasehold improvements, lease deposit, inventory, insurance, fixtures, signs, equipment, furnishings, office supplies, legal and financial consulting fees, licence and permit fees, and deposits for utilities.
Operating expenses: ideally, you should have enough capital to cover the amount of your monthly overhead for six to 12 months. These expenses may include franchisor royalty and consulting fees, advertising and marketing expenses, rent, insurance, inventory, utilities, wages, administrative expenses, loans and leases and legal and accounting fees. It’s also wise to add another 15% per month for unplanned expenses.
Personal expenses: you should also include a resreve to cover personal expenses for yourself and your family until the franchise begins to generate sufficient cash. Six months is generally a sound guideline.
4. Write a business plan
Now you know how much you’ll need; so how and where do you get it?
You may be independently wealthy and have all the funds you need to get your franchise up and running without the need for additional financing. For most new franchise owners like Marco, however, outside financing is a necessity. And for that, you’ll need a business plan.
Anyone who lends you money will want to know what you intend to do with the funds and how you expect to pay them back. A business plan should provide an overview of your franchise, and outline your goals and how you intend to achieve them. The basic elements of a business plan include the following.
- An overview of your business and how you plan to use the funds to make it succeed
- market analysis – target market, prospective customers and their needs and characteristics
- competitive analysis – including your industry and competitors and the strengths, weaknesses, opportunities and threats for your franchise
- merchandise profile – product descriptions and positioning and pricing strategy
- operations – key personnel, staffing plan, facilities
- marketing strategy – sales tactics, advertising and promotion plans
- financial plan – list of capital requirements, projected balance sheet, a breakeven analysis, and cash flow projections
While many new business owners will look first to the banks for financing, before you take your business plan over to your local banker, you should know that banks consider retail businesses to be high risk ventures. Your banker will be looking to see that you are allying with an experienced franchisor with a long list of successful franchises.
Banks typically provide short-term financing for working capital and operations. For a retail operation, this might be about 50% to 65% per dollar of equipment and up to about 70% of receivables less than 60 days old.
In return, your banker will expect to see that you have personally invested at least 25% of the total funds required to start the business and will require personal guarantees up to the maximum amount of the loan. The banks want to see owners who are prepared to take on personal risk for their businesses to succeed.
If the bank doesn’t provide sufficient cash to get your franchise up and running, and you don’t have family or friends who wish to invest in your business, there are a couple of other sources of helpful financing for retail franchises.
Along with lending on hard assets, the Business Development Bank of Canada (BDC) provides loans for land and buildings, which banks are reluctant to finance. Generally, the BDC holds the first mortgage and lends up to 65% of the fair market value of the asset. In return, you pay interest rates that are a bit higher than bank rates but extend over longer terms.
GE Capital Solutions is another helpful financing source. GE finances many franchise businesses through a range of lending products, growth capital, revolving lines of credit, equipment leasing, cash flow programs, and asset financing. The company also offers longer loan terms than banks do, ranging from seven to 10 years, depending on the franchise model.
While your business plan will prove to be essential to secure financing from sources such as these, you will find that it is also an essential tool for you – to ensure that you’ve covered all of the elements needed for your franchise to succeed.
5. Set up a financial management system to succeed
Marco was able to develop a comprehensive plan that demonstrated to lenders that he had everything together and he was able to secure the capital he needed. Then the issue became how to manage this working capital to make it through the early make-or-break months. Following are some of the checks and balances that can help to monitor progress and flag problems.
- Prepare monthly cash flow statements and compare with the projections in the business plan to ensure that you’re on track.
- Monitor accounts payable and receivable on a monthly basis.
- Monitor sales on a weekly basis and compare with projections.
- Reconcile cash and inventory weekly.
- Review cost of sales monthly to ensure ordering and pricing are appropriate.
- Compare labour rates as a percentage of sales every month to ensure you are staffing at the right level.
Marco’s new franchise is underway and its future looks promising, thanks to his diligent approach to assessing the financial viability of this venture. If you have your dream retail franchise in sight, be sure to walk through these five steps – and not only will this provide a strong financial foundation to start your business, but it will support your enterprise for long-term success.
Rick Chittley-Young is a principal of BDO Dunwoody LLP (www.bdo.ca). BDO is one of Canada’s leading accounting and advisory firms, which helps entrepreneurs, family businesses, franchisors and franchisees succeed. If you have questions about this article or would like to receive BDO’s “Tax Factor” newsletter, contact Rick in the Oakville office at (905) 844-3206 or rchittley@bdo.ca.
