Building a successful franchise system is like building a skyscraper in New York City: without a steel enforced and robust foundation, the building will collapse. The higher you build, the stronger and more intricate the foundation must be. Many of the young franchise systems we encounter approach us asking for advice about how they can ensure success for their brand and their franchisees. While in their early stages, some of these brands’ financial decisions seem inconsequential when decided. However, they actually have a lasting impact that can affect the financial foundation and limit the brand’s growth.
Right Tools in the Toolkit
A common mistake that young franchisors make as they grow is to hire or promote employees that are inexperienced and lack the skills necessary to succeed in their role. I recently worked with a young franchise brand who had recruited a twenty-something visual arts school graduate to be their Director of Finance. This person was intelligent, but he had very little accounting or finance experience, and zero background in franchising and operations. While a professional degree matters, hiring for specific skills and experience is equally as important. Think about it: Decisions such as what financial processes to mandate to franchisees, how to setup the financial reporting structure for the company, or selecting what financial software would best support a growing franchise are the keys to both franchisee and franchisor success. His lack of experience – coupled with the minimal size of his network in franchising – impaired his ability to lead and shepherd the brand financially.
Conversely, the CFO of a Fortune 50 company looking for an “entrepreneurial fix” likely is not the right hire for your emerging infancy-stage brand, either. Coming from a mature and stable company to an environment of daily priority changes and fire drills does not always bode well for someone whose assistant has an assistant. Finding the right blend of experience and sophistication, while still being an all-around utility player, is critical for your brand’s growth during the early stages.
As you grow, build your network of other franchising professionals so you have a group of peers that can be a sounding board as you make decisions regarding new hires, promotions, and other organizational changes. Franchising, although having similar attributes to other businesses, is distinct in nature. An understanding of multi-unit economics, the regulatory landscape of franchising, and the nuances of the franchisee and franchisor relationship are paramount in franchising. Rest assured that an entire article could be dedicated to this topic, including many horror stories of franchisors failing based on uninformed and bad opinions from CPAs, accounting firms, or attorneys who don’t understand that a UFOC no longer exists or how a franchisor’s recognized earnings in the FDD audit can drastically impact franchise sales. Overall, a professional degree does not equate to experience in franchising, so hiring the right way both internally and externally truly matters.
Although unsexy, the foundational tools for your accounting and financial reporting are the “SPANX” of your company. Holding it all together with solid foundational tools will allow for clarity, timeliness, and accuracy of your financial reporting. The one key item to require as it relates to compliance by your franchisees is a single point of sale system (POS). This may sound like a basic requirement, but I recently spoke to an emerging brand that is allowing franchisees to select their own system. Franchising is built on uniformity of systems, efficiencies, procedures, and processes, including a mandated uniform POS system. Allowing different POS systems requires additional resources and manpower for your existing staff to access, track, and report on results. Young brands are always stretched thin on labor – why make this a pressure point? Different variations of POS systems also make collecting royalties via ACH difficult and cumbersome. As the franchisor, you likely cannot have one master login across all these systems to pull sales data and collect ACH payments. Would you allow a franchisee to change your logo or the recipe of your brand? Obviously not. Why allow them to make decisions regarding the POS system that can have an equally devastating impact on their and your financial livelihood as the lamb-flavored smoothie?
Similar, but slightly different, is requiring a uniform chart of accounts (COA) from day one. This may seem irrelevant now, but many companies who do not mandate this discipline have, at worst, experienced royalty fraud and, at a minimum, spent excessive time creating comparable financial statements between franchisees. It also causes difficulties with preparing a robust and accurate Item 19 for their FDD. A uniform chart of accounts ensures comparable financial data from unit to unit. Although coding errors can occur despite this, it is much more likely to accurately report and analyze P&L data, reduce the risk of royalty fraud, and have confidence in financial metrics reported in the Item 19 of your FDD.
Additionally, collecting royalties via ACH on regularly prescribed time and date is imperative. Many new franchisees manage their business via their bank balance. If a franchisor is not collecting royalties on a systematized and regular basis, royalties are often sent in late, not sent in at all, or drafted from franchisees’ accounts when the funds are not there. From the franchisor perspective, having a predictable and automated inflow of royalties each week makes cash flow planning and ad funding needs easier to predict, as well as keeps the franchisor out of the collections business.
There is often a euphoria that comes when you sell your first franchise and collect your first franchise fees. It can seem like that cycle of incoming cash, signed contracts, and initial “first franchise” matches will go on forever. Regardless of how strong your unit economics and your brand are, eventually there will be a first misunderstanding, first fight, and first period of angry silence between the franchisor and the franchisee. The question is what can you do early on to minimize those occurrences from a finance and accounting perspective? Requiring reporting discipline will set your company and your franchisees up for success.
Why does this matter? Because bad habits start early. Franchisors are busy setting up systems, running company-owned stores, and hiring the right talent. Emerging franchisors have more work than they can handle and chasing down franchisee P&Ls often falls to the bottom of the list. If you do not institute a level of rigor from the first month forward, many franchisees will not prioritize tracking and managing accurate and timely financials. Franchisees are busy trying to successfully launch and run their franchise locations. Oftentimes what gets lost is focusing early on the basic key financial drivers that will tell you how your business is doing. Many franchisees will not prepare financial statements for months, as ridiculous as this may seem! I can’t tell you how many franchisees we see that are only concerned with the level of cash in their bank and neglect to focus on the key drivers of their business, such as labor costs, food costs, and marketing expenses. Recently, a brand approached us about helping them collect franchisee financial information for their 175+ units. They told us only 35% of their franchisees are reporting to them at all. If franchisors do not require the timely and accurate submission of financial statements from day one, the franchisees will develop poor habits, and reversing those behaviors is nigh impossible.
Today in San Francisco, a five-year-old 56-story high-end residential building is sinking. The engineers, architects, and building owners are all immersed in litigation over who will foot the 100-million-dollar bill to fix the issue. Building your brand right is not just about the front of house customer experience and menu offerings. Your back of house accounting foundation is what will allow your brand to grow and stand tall for decades. Don’t let your brand sink slowly; dedicate the appropriate amount of time, the right personnel, and install the right procedures and reports.