When clients want to open a franchise

By Lisa MacColl | June 1, 2012 | Last updated on June 1, 2012
4 min read

The expert David Wilton, MBA, Director of Small Business, Scotiabank, Toronto

Client profile Jack, a lifelong public servant, is an assistant Federal deputy minister. Sherry is a high-school teacher. Both plan to opt for early retirement this year, but at 55 and 56, they aren’t ready to stop working. They have run a small bed-and-breakfast in their log home in the Gatineau region of Quebec for the last 20 years.

The situation

Jack and Sherry have just under $1 million in retirement savings, plus blue-chip public-sector pensions. They’re not keen on travel. Their bed-and-breakfast is worth another $800,000 because it sits on 100 acres of land. Armed with their B&B experience, they feel ready to take on a larger venture—a franchise.

The issues

Jack and Sherry want to stick with the hospitality industry, and Choice Hotels is planning to open a location in their area. Sherry has never managed staff, but is confident her years of teaching will compensate, especially for young employees. As head of large departments, Jack has delegated day-to-day issues to middle managers. He’s been in charge of all the bed-and-breakfast’s marketing, and son Mark built its website.

7/10. The advisor will need to ensure the dream and reality of franchise ownership don’t collide.

The couple live an hour north of Ottawa, in an area popular with outdoor enthusiasts. The population is under 1,000, so businesses rely on tourism. Recent hikes in gas prices have led to a decline in B&B bookings; there’s no train or bus access.

The solution

Wannabe franchise owners pose a special challenge, says David Wilton, director of small business for Scotiabank. “The dream of franchise ownership can cloud the reality. Reputable franchises bring the value of the brand and a proven track record, but investors need to do due diligence.” Franchise fees, asset requirements, and marketing and training support vary widely. (see “What a franchise costs,” below).

What a franchise costs?

Franchise Name Franchise Fee Investment Required Start-up Capital Required? Training
Liberty Tax Service $25,000 $33,350-$54,900 n/a 5 days
Speedy Glass $25,000 $100,000-$300,000 n/a Not specified
McDonald’s $45,000 $500,000; unencumbered assets n/a 1-2 years
M&M Meat Shops Inc $35,000 $100,000-$500,000 n/a 4-6 weeks
Second Cup Ltd $40,000 Equity of approx. $350,000 (cash and assets) n/a 6 weeks
Baskin-Robbins $20,000 $200,000-$500,000 $125,000 unencumbered cash; $250,000 net worth 4 weeks in Burbank, CA
Tim Hortons $50,000 $194,000 n/a Not specified
Swiss Chalet $60,000 $1.5 million to $1.7 million $500,000-$600,0000 unencumbered assets 10 weeks
Choice Hotels Canada $25,000-$50,000 At least $3 million At least $1 million Company required
Pizza Pizza $30,000 $100,000-$200,000 $100,000-$200,000 8 weeks

A franchise fee alone can reach the high five figures. “If you are opening a franchise that requires equipment, that’s a double hit. Look at both personal and business costs to ensure you have enough capital in place for unexpected expenses.”

Source: Gowling Lafleur Henderson LLP

Wilton says some new owners assume the brand will carry the business. Yet it still takes time to build customer loyalty.

“There could be many long days until you generate enough sales to hire adequate staff. Most franchise owners will pay staff ahead of themselves. They need adequate financial resources to weather that kind of hit to the personal finances.”

At a minimum, the couple needs enough cash on hand that’s shielded from the new business to cover at least six-to-eight months of living expenses.

That’s not going to be easy. Jack and Sherry’s investment portfolio was designed for wealth accumulation, and their current asset allocation is 80% equities. They made nominal contributions to a TFSA for emergency repairs to the B&B, and maxed out RRSP contributions.

If they buy the franchise, they’ll need to shift contributions away from their RRSP to the TFSA so they can access cash without taking a tax hit. And they’ll have to switch their TFSA’s asset allocation to balanced to provide more income. Since they’re not in corporate-class funds, they’ll pay taxes on any gains when moving those funds.

What’s more, paying the start-up costs means they’ll have to liquidate their retirement savings. That will realize both gains and losses, so a tax expert will need to be in play to maximize the writedowns.

While franchise owners receive preferential supplier and insurance rates, operators may be limited to specific suppliers, store layouts and products, regardless of local preferences and availability. Those requirements are in the franchise contract.

8/10. After speaking with their advisor, Jack and Sherry realized they needed to do a lot more research. They’d underestimated the start-up costs and were reluctant to put all their retirement funds at risk. They’ve put the franchise idea on hold, and are focusing on building their B&B client base instead.

The toughest conversation Jack and Sherry’s advisor must have is regarding business suitability. “Do your clients have the necessary skills to run a franchise? If not, how will they compensate?” says Wilton.

“Not everyone is ready for the challenges of running his own business. Conversely, a person who likes to blaze his own trail may not do well under the prescriptive confines of a franchise arrangement.

“Most agreements have a clause that allows the franchisor to take back the franchise if it’s not run according to the terms.”

Lisa MacColl