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The Hidden Cost of Weak Standards: Why Franchisees Need Financial Cushioning By Joe Caruso Franchising is a proven path to business ownership, offering a blueprint for success through a strong brand and operational support. But beneath the surface lies a critical challenge that many franchisors overlook: weak financial standards for prospective franchisees. Insufficient requirements for available cash and net worth can lead to cascading problems for franchisees and, ultimately, for the entire brand. Financial cushioning isn’t just a safeguard for franchisees—it’s a necessity. Here’s why it’s time for franchisors to take a hard look at their financial standards and ensure their franchisees are set up for long-term success. Are Your Financial Standards Stuck in the Past? If your franchise’s available cash and net worth standards haven’t changed in decades, you may be courting disaster. The economic landscape has evolved, and costs have soared across the board—from labor to rent to marketing. Standards that were sufficient 20 years ago may leave today’s franchisees woefully underprepared. When financial requirements are too low, they open the door to underqualified candidates. These candidates might express interest in the opportunity, but their inability to handle the financial realities of business ownership can lead to cash flow issues, operational struggles, and high turnover among staff. The Lead Qualification Bottleneck Some franchise sales teams lower financial thresholds to attract more leads, thinking this will widen their pool of potential franchisees. However, this short-term strategy can backfire, creating a clogged lead funnel filled with underqualified candidates who will struggle to succeed. Weak financial standards lead to more underprepared franchisees entering the system. This often results in: Locations failing to achieve profitability. Franchisees unable to afford experienced managers or team members. Resources spent managing distressed franchisees instead of growing the system. For franchisors, these struggles can erode brand reputation and disrupt the flow of systemwide operations. The Multi-Unit Mirage The risks of weak financial standards are amplified when franchisees sign multi-unit development agreements. Franchisors love the appeal of scaling quickly through multi-unit deals, but without the proper financial foundation, these franchisees often fail to build out their territories. Instead of driving growth, undercapitalized franchisees leave promising markets underdeveloped. This creates opportunity costs for the franchisor and impacts systemwide momentum. Worse, these failures often drain resources as franchisors try to salvage distressed multi-unit agreements. Click-Thru to read more...https://lnkd.in/e_yvf_vK
I always tell my potential franchisees to speak with as many franchisees as possible until you start hearing the same thing over and over again. On occasion they find out that the financial requirements the franchisor initially laid out are not realistic. Franchisees are paying more to get their franchises up and running than was indicated to them. This makes people wary about the franchise in general and then they wonder about whether or not the franchise and the information they provide can be trusted. At this point my people will pass on the franchise and I will not present the franchise again. Always best to over state the initial requirements to make sure you only have well funded franchisees and to keep your reputation intact.
I completely agree, Joe. Unfortunately, I’ve seen many franchisors—especially emerging brands—make the critical mistake of accepting sub-par franchise candidates for two main reasons: A. Excitement that someone is showing interest in their brand. B. Pressure to meet "goals and metrics." This short-term thinking can lead to significant long-term challenges. When franchisees are undercapitalized from the start, they face financial strain as soon as their unit opens—burning cash on labor, inventory, and operational expenses. As funds run out, they begin to cut corners, starting with essential areas like training. Without proper training, the team is ill-prepared to deliver the brand experience, which directly impacts new customer impressions. Next, the cuts often extend to marketing. The combination of reduced training and marketing support creates a downward spiral that’s incredibly difficult to recover from. That’s why I work diligently with my clients to ensure they fully understand the financial and time commitments required to succeed with the brands they choose to investigate. Franchisee success is in everyone’s best interest, and it starts with informed decisions.
This article highlights a seminal point. When unit closures or footfall reductions occur, franchisors often take the blame. However, vetting the financial condition of franchisees is more critical than ever. In the short term, everyone wants to close a deal, but in the long run, under-capitalized franchisees can bring down the entire franchise system. This is especially true for multi-unit franchisees with exclusivity agreements, which can be a double whammy. It's essential for franchisors to reassess their financial standards and ensure franchisees have the necessary financial cushioning for long-term success.
This! Can I just say this story touches on so many things needing conversation and change in franchising. I often say that when Franchisee’s make their first purchase of a license they have not given an ounce of thought to anything regarding their second and beyond! So, even if they buy a three pack or development area they are still completely unprepared for their first but making decisions on subsequent ones with no foresight or planning! At the very least a Business plan surrounding subsequent openings for all purchased licenses should be a part of the discussion! I get it! Make sure you have borrowing capacity for at least two Units in most cases as your first one may not fit the norm (ask anyone opening during and post Covid!). Choosing sub par Real Estate or having staffing problems will slow your path to B/E but perhaps not your desire to continue to grow. Lastly! Do not open too fast or too many at a time! The cash gap is painful and perhaps dream killing so don’t go there! Nothing is more painful, more frightening, or more stressful than seeing your dream moving forward slower than planned and due to the cash gap you cannot borrow cash flow monies and your dream starts die on the vine!
An under capitalised franchisee can be a recipe for disaster, and its often not their fault. The starting point for me in any franchisee recruitment process is a financial plan which shows exactly what a franchisee will need to invest, and to have in reserve. This should NOT be based on the top percentile of franchsiees in the network, but be a realistic assessment of the actual requirement. Any such model should also stress test these figures, ie if turnover grew more slowly, could they survive. Only then should a franchisor start the process of recruiting franchisees, and in this process must be transparent on the funding likely to be required. Finding a franchisee who has less capital available, and 'fudging' the figures to make it work is NOT honest, ethical franchising. It's a tough market our there for many franchisors, but it will only get tougher if standards are lowered and the wrong franchisees are brought on board
Joe has once again asked us to respond to a very important topic. With apologies to him and each responder, I would like to change up this discussion a bit. I hope you will stay with me and respond. Without question, any franchisor who accepts a candidate who is not financially qualified to purchase AND BUILD their franchise is contributing to the company's franchisee "turnover" rate, while lowering the company's integrity and eventual resale value, asking for a lawsuit, prompting state (and potentially federal) punitive legislation. Right? I have been awarding franchises for 30+ years, and have built teams that have produced 1,675 franchises. Early on, we too awarded franchises to individuals who did not have enough access to capital to build a strong, productive franchise. Shame on us. MY REAL QUESTION IS THIS... Please look for my follow-on piece in response to Joe's Question. Mick
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Insightful. Have experienced this with both candidates and franchisees. Some people don't understand net worth or required collateral to qualify for financing. Lenders just don't give out money. Finally, there is also a Catch-22 dynamic. Some franchisors want the candidate to run the business on a day-to-day basis and not be a 3rd party investor. Many of these prospects don't have the capital while the folks with the money have other business interests and don't want to be operators but instead put a team in place.
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Head of Franchise Development
3wThe franchise fee constitutes a minor fraction of the total investment. It is imperative for both parties to fulfill their professional obligations by ensuring that the new franchisee possesses adequate capital expenditure (CAPEX) and operational expenditure (OPEX) resources. As part of our standard procedures, we now provide prospective franchisees with an Excel document designed to facilitate comprehensive financial analysis, including fit-out costs, CAPEX, OPEX, sales forecasting, cash flow management, profit and loss statements, and an asset register. Franchising entails not only mathematical considerations but also the essential management of brand integrity and the provision of high-quality service. Any failure to address these aspects would be fundamentally irresponsible.