Starting up one's own business has a lot of emotional appeal and is becoming attractive to an increasing number of Canadians who are looking for ways to insulate themselves against layoffs. Wit- ness the sharp increase in home businesses in recent years and the growing trend by corporations to contract out services that were once done in-house. Other Canadians are turning to franchising for the answer.
But going into business for yourself does not necessarily solve future employment problems or make you rich. There are pitfalls, even with franchises, and these must be weighed carefully before you make a final decision. Above all, know what you're getting into and what the odds are for your success.
Let's take a close look at franchising.
Franchising: Entrepreneurs need not apply
You'd think it would be the exact opposite. But it isn't — there's a lot of anecdotal evidence to suggest that entrepreneurs make lousy franchisees.
There are exceptions, of course, but the best candidates are those with strong managerial and communication skills — above all, people who are prepared to toe the line and follow the franchiser's directions to the letter. If you are — and you've picked the right franchise — there's a good chance you'll succeed.
Entrepreneurial types find franchises very restraining and con- fining, says John Sotos, a partner with the Toronto law firm of Sotos Kravanis who has been advising franchisers and franchisees for the past 18 years. Even if they do well, adds Sotos, they eventually get restless and begin to resent the franchiser and the franchiser's dictates as to how the system should be run.
At some point, entrepreneurs get the feeling that they know
more than the franchiser and could do better on their own.
Generally, if they're unhappy, they don't do well.
If you are entrepreneurial and like the franchise concept, think about becoming a franchiser instead. You'll probably do better.
The skill set is different — more in keeping with the entrepre- neur's special strengths. Here these skills work in his or her favour.
For most people, however, the only real option is buying a franchise. The best is one with a proven, successful system that requires the franchise to follow a number of preordained steps and procedures that have demonstrated a high success rate.
This is where many people make their greatest mistake, says Sotos, who has guided hundreds of prospective franchisees through the process. They see franchising in terms of proven, successful systems like McDonald's or Midas and associate that image with a start-up outfit that hasn't even sold its first franchise.
That's a crucial point. In the case of new franchises, you don't have a successful system. They're unproven and often include inexperienced management or a system without the financial resources behind it to make it successful.
Strong management is critical. Ideally, the people behind the franchise should have strong industry experience and have a team in place to assist you with marketing, store operations, and site selection. Ability to administer the franchise's advertising fund in a professional manner is essential. These funds should be segregated from the franchiser's other funds. Saying that the fund exists, without evidence that it does, or how it is administered, is not good enough, Sotos stresses.
These points are givens. But if you don't have these resources at your disposal, how can you get the support you need? And you will need this help. One of the main reasons people choose franchising over building a business from scratch is that they are able to tap into a mass-marketing program they could not otherwise create on their own — in essence, take advantage of the brand recognition a national franchise offers.
The other main reason: to take advantage of volume purchasing.
This is important because it gives the franchisee a competitive edge. If the franchiser does not have this advantage — or is not prepared to offer it — I would very seriously question whether you should buy that franchise.
Typically, people who buy franchises are going into business for the first time. They still think as consumers and don't always value professional advice. These individuals can't find ready employment in their fields, and deep down they always had a yen to go into business for themselves. Usually, says Sotos, they go into something they enjoy — not a bad thing in itself— but the problem is that they go into the franchise with a romanticized image of what is involved. That's why so many go for bar and restaurant franchises. The reality of being an owner/operator of a bar or restaurant, however, is totally different from that of being a patron. In most instances, the people who go into these franchises are not really prepared for the long hours, the high staff turnover, and the customer-relations problems. The result — usually failure.
The other big pitfall — people simply fail to do their home- work. No one, says Sotos, should buy a franchise unless he or she has it vetted by experienced franchise professionals. That includes lawyers, accountants, and bankers with a solid background in franchising — people who have seen it all before and who can show you where the pitfalls are.
You should expect them to walk you through the process and use their experience to show you what you can expect from the franchise agreement you'll be asked to sign and what, particularly, stands out as unusual.
An agreement, notes Sotos, that front-end loads all fees and/or gives the franchiser the right to force-feed merchandise on the fran- chisee has the potential for abuse — and that's what usually happens.
Once people understand, in plain English, what's involved — as opposed to the typical platitudes you see in many of these
contracts — they are able to make a decision with their eyes wide open and with no surprises at the end of the road. If you go through the financials with an accountant who understands all the ins and outs of franchising and discover, for example, that the expenses outlined in the pro forma statements are understated to the extent that the franchise is likely to generate a loss, you won't be as eager to buy that franchise.
Bottom line: Before you sign anything, get advice. The best you can buy. It's much, much less expensive than losing
$250,000, and it will save all the family discord, including marriage breakdown, that often follows in the wake of a financial loss of this size. There's more at stake than just the money you're putting up, warn experts like Sotos. If you're in your midges and lose your family as well as your savings, it's a devastating experi- ence many individuals find hard to recover from.
Legal costs for this kind of advice can run anywhere between
$1,500 to $5,000, depending on the complexity of the franchise agreement. Don't let that stop you, even if the franchiser tells you that he or she won't change the agreement to meet concerns from your lawyer. That may or may not be the case — but if you're putting up $250,000, you really should know what you're getting into and what your chances for success are.
No matter what the franchiser tells you, says Sotos, most franchise agreements are negotiable. So don't go in with the approach that the franchiser won't budge. In most cases, changes can be made — to your territory or even to some of the financial terms. If the franchise is a new system, you can probably negotiate a longer term without ponying up extra money. Or be able to keep the same royalties when the contract comes up for renewal.
If you don't try, you'll never know.
As a rule, the more established the franchise, the fewer the changes you'll be able to make. If the franchise is a proven success, the franchiser will be less likely to allow you to tinker with the formula.
This is especially important if you're buying a new franchise.
In many of these cases, the franchise agreement may be full of holes. Don't assume that franchisers always know what they're doing. They also make mistakes. In some cases, their franchise agreements are adapted from other franchise contracts and are little more than a composite of these agreements rather than an agreement unique to the needs of the particular franchise, or they may not take into consideration your strengths, weaknesses, and philosophy.
Note: Once you sign on the dotted line, you will not be able to make changes later.
Given the potential for misunderstanding and for abuse, you would think a lot of these agreements would wind up in the courts. Some do, says Sotos, but most franchisees have mortgaged their homes and invested their life savings in the venture and have very few resources left to take their case to the courts.
While all this may sound negative, there are also a number of stunning success stories in franchising. It's a great way to do business — if you have the right ingredients in place and you buy the right franchise, one with a distinctive trade name, a competi- tive advantage, solid training and retraining programs, as well as an ongoing monitoring system to help keep franchisees on track.
Here's a partial list of some of the things you should expect before laying down a cent on a franchise no matter how great the opportunity sounds in the franchiser's advertising:
* An established, proven, and highly successful system in place.
* A marketing program to promote the franchise.
* Careful selection of potential franchisees. In some instances, the only qualification is having the money to put up. Candi- dates should fit the franchiser's profile.
* Training and retraining programs.
* Regular inspections — and timely advice to franchisees where they have fallen short.
* Effective reporting and accounting systems — so that the franchisee knows when his or her costs are out of line and how to correct any mistakes. Good franchisers also have established profiles of candidates who are most likely to succeed. There are essentially two types of successful candidates: those who feel comfortable and who are prepared to follow dictated mandates (business is increasingly complex, and you need someone who is not going to resist a proven success formula), and those with people and communication skills.
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Financing: Make sure you do your homework first
If you don't do your financing homework, your banker will insist that you do. Before any money changes hands, he or she will want to make sure that you've investigated the franchise from head to toe — and that you fully understand the nature of the franchise, especially how much support or lack of support you can expect from the franchiser.
Dan Farmer, senior manager, national franchise market, for the Royal Bank of Canada, suggests you do a lot of tire-kicking before you make up your mind. That includes talking to other franchis- ees in that system. "We want you to know what you're getting into. It's not in our interests — or in the interests of the franchiser
— to have you fail."
Many leading franchisers, he notes, have designed national banking packages with one of the major banks. In these cases, that bank already has a good understanding of the franchise, how it operates, and its potential.
What does the bank look for? "Management expertise, expe- rience, energy, drive, and commitment. You can sense it almost immediately. We look for past examples where the individual has demonstrated these qualities," says Farmer.
How much will the bank finance? That depends on the fran- chise — the size and health of the system as well as the sector it's playing in. There's no simple formula. In most cases, no formula at all. As a rule, the bank will expect you to put up 25% to 30%, but even that figure, adds Farmer, can be tailored to the individual and the franchise itself. A highly profitable system with a success- ful track record will obviously require less.
In fact, the equity-to-loan ratio used by the bank for a partic- ular franchise could be viewed as a criterion of the kind of risk you might be undertaking.
Guarantees could also be involved, but they, too, depend on the track record of the franchise. If you expect 100% financing, you can assume that some form of guarantee will be involved.
Bottom line: Surround yourself with franchise-friendly profes- sionals — lawyers, accountants, and bankers — and leverage their advice. Ideally, you should tap into a network of profession- als who have dealt with each other before and who can work together with you and the franchiser.
The bank will want to know you're getting the best advice you can.
Also worth noting: When you're buying a franchise, you're really buying someone else's mistakes and the knowledge that has come from them — without having to go through the pain.
What about using your severance to finance a new business?
Using your severance for financing sounds great, at least at first glance, when you're scrambling for money to start a new business
or finance a franchise — but it may not be your best option.
If you do, you'll lose half of your severance to the tax collector.
Unless it is sheltered, the award will be added to your income in the year it is received and taxed at your full marginal rate. In most instances, that will be 53%.
A far better strategy would be to roll as much of this allowance into a self-directed RRSP and focus on using that money for your retirement. Once taken out, it cannot be put back later. So think long and hard. It really isn't your best option.
A better approach would be to take out a new mortgage on your home and use these funds to finance your new business.
This way, the interest on your mortgage now becomes tax de- ductible, and you'll win both ways — you'll be able to escape taxation on a big chunk of your retirement allowance, and you'll have a tax-deductible mortgage that can be written off against your business as interest on a business loan.
Are You Ready for Retirement?
Never put off until tomorrow what you can do today.
There probably will be a higher tax on it.
Start planning for your retirement now
You'd be surprised how many people aren't prepared for their retirements. I see a lot of worried faces at seminars these days
— people who are approaching their retirement years and are suddenly aware that they are running out of time. Virtually all are looking for magic solutions, knowing deep down there aren't any and that, if anything, the noose will become a bit tighter as universal programs fall by the wayside.
If you're in this position, there are still a few things you can do
to get off on the right foot. If you're within five years of retire- ment, start planning seriously now. You'll need that time to put yourself in a position to take advantage of all the options open to you.
First step: Put your financial house in order. That includes paying off all your debt — or at least as much as you can — and developing a realistic retirement budget that covers your basic needs, leaving a bit of room for inflation.
Second step: Look at the projected cash flow available to you in retirement and develop an investment strategy that will pro- duce the income you'll need to match your retirement needs.
In most cases, that means coming to terms with your risk tolerance. That's a toughie. Most people will tell you that they understand market volatility, that they can handle a market correction — at least until there's a major sell-off. Then emotions run amok, and all the best-laid plans in the world go right out the window. Make sure this doesn't happen to you. It can make a big difference in how you'll live in retirement.
There are two ways to deal with this:
* First, understand how much risk you can really handle emo- tionally. That's critical if you want to avoid mistakes later on.
That means putting your money in investments that won't keep you awake at night when things go wrong. And they will.
* Second, and perhaps even more important, understand how markets work and how to use a carefully crafted multi-dimen- sional investment strategy that not only reduces risk but also provides a consistent, superior rate of return year after year.
Third step: Maximize your RRSP contributions during the years you have left. If you still have unused contribution room, borrow if you need to, but make those contributions.
This will do two things. It will help to reduce your taxes while you're still working and enable you to amass a greater nest egg
inside your RRSP that will compound on a tax-free basis. The sooner you do this, the more you'll have to take out every year in your retirement. Even three or four years can make a huge difference. In most cases, you should be able to repay this easily over the next five years.
This brings up another point. Risk tolerance. There was a time when you could earn quite respectable double-digit returns from fixed-income investments like GIGS. But those glory days are long past, and if we want to maximize our retirement income, we really have no option but to include stocks as part of our investment mix. I say "no option" because if we don't — given today's low- interest rate environment — we will most certainly outlive our money. And these conditions are not likely to change anytime soon.
If you've been a GIG investor, take the opportunity to learn about time and risk. As a general rule, stocks not only outperform investments like GIGS but also do so consistently — and at virtually no risk — if held over a long period.
How long? At least five years. A recent study on investment returns by Scotia Capital Markets shows that in no five-year period during the past 35 years have equities lost money. That's not all. It also shows that equities outperformed fixed-income investments, including GIGS, for 25 of the 35 years reviewed in this study. The only time they didn't was during the 19805, when interest rates skyrocketed to historic highs in the Western world.
Add this to the fact that people are living longer and that they will require income for at least 22 years. Without the kind of returns generated by stocks, most people simply won't make it
— if they rely on Gic-type investments.
The best way to reach your goals is through a balanced portfolio that includes growth as well as blue-chip equity funds, bonds, and foreign investments. By adjusting the mix, you can reduce or increase the volatility — and returns — in keeping with your risk tolerance, enabling you to use a multi-dimensional strategy to the maximum.