Franchising: learn from others mistakes

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A law firm operating as a franchise has posted recent results. These show a reduced loss but concerns as to the firm’s financing, support, and brand dilution as a result of the franchising model. Investors and franchisees appear concerned.

In this insight we

  • Look at why the franchising model has come into trouble.
  • Suggest ways for improvement.
  • Deal with the issues that each party is likely experiencing.

QualitySolicitors (“QS”) reduced its losses by more than £1m in the latest set of results, but QS remains reliant on millions of pounds worth of investment.

An example of how franchising your business can quickly go wrong

The results are not only a concern for QS, but also for QS’ investors and franchisees. Turnover dropped because franchisees left the model. QS’s directors took a remuneration cut. However, investors in QS are likely to be most concerned, as the total shareholders deficit now stands at just under £16m. Partly this is a result of rapid growth, increased loan facilities and on-demand interest payments.

Our analysis of QS franchise mistakes

QS, founded in 2008, permits high street law firms to use the QS brand, logo and database for marketing. QS initially secured lucrative contracts and grew rapidly in the first few years of operation. However, new franchisees emerged, and the brand’s image has been diluted. Investors and original franchisees to the franchise agreements are concerned as to how the QS brand is to maintain itself.

QS admitted that it grew too quickly. Enhanced due diligence on the chosen franchisees could have gone some way to ensuring that the brand’s reputation was maintained. As with any company looking to expand, financing is crucial. The right balance has to be struck between debt and equity financing, a significant level of both is likely to cause conflict during the stages of expansion – this is what QS is now experiencing.

How to avoid franchising mistakes

When setting up a franchising model, the devil is in the detail. The rewards can be lucrative. Franchising is an excellent method of spreading a brand and quickly growing a business. However, the QS story shows how the model can run into financial difficulties. Expansion is good, but the franchisor has to be careful not to dilute the brand by expanding too rapidly.

As can be seen from the QS story, the number of franchisees dropped by almost 20% in two years. The cause is not known, yet brand dilution, lack of support, and concerns over financing are likely to be common contributors.

6 top tips for franchisors

  1. Know your business, its brand, and how it is perceived;
  2. Know how you want to grow, both by market and territory;
  3. Perform enhanced due diligence on your franchisees;
  4. Set the right restrictions on the franchisees;
  5. Provide franchisees with unrivalled support to protect your brand; and
  6. Know the legalities, both to financing and operating a franchising model.

Lessons for franchisees

If you are an established business, your brand is likely to be strong enough to keep a customer base and limit competition. However, using a franchisor’s brand can enhance growth and increase revenue.

Operating as a franchisee

QS’ franchisees and investors are likely to be concerned as to the strength of QS’ brand. QS has over 100 members. Should one of the members not perform as desired, or provide a poor level of service, the impact is unlimited. Other members of the franchising model will suffer. Perhaps more importantly, other brands are beginning to mirror QS’ initial successes, diluting the originality of the brand and its format.

QS’ investors have a say in how the business is run, enlightened shareholder value is pivotal to a business’s success. As with any business, investors need confidence in the business’s growth plan.  QS’ investors may attempt to cut their losses by reducing QS’ ability to support its franchisees and limiting brand promotion and protection expenses. This is detrimental for franchisees, with support stifled and potential for the brand to be passed off by others.

6 warning signs for franchisees

Look for these signs:

  1. The franchisor’s behaviour in the media, or litigation press;
  2. A track record of unpredictable financial results;
  3. Unhappy investors in the franchisor’s business;
  4. Franchisor competition affecting the brand’s perception;
  5. The franchisor’s gearing ratio; and
  6. Excessive sales talk from the franchisor – numbers trump words and disclosure is important.

Implementing a franchise model

Franchising a business is exciting, both from a franchisor and franchisee’s perspective. However, how the growth is financed is of paramount importance for both parties. QS is experiencing financial difficulties because of its financing choices. Striking the appropriate balance between equity and debt is key. We’ve enabled franchisors and franchisees to raise finance through alternative means, e.g. unquoted private mini-bonds and strict sources of crowdfunding.

Operating a franchise seems easy at the outset, yet the complexities are outlined by the QS story. Know the risks from day one, and take steps to limit them.

Helen Curtis is a partner in the commercial team. Helen acts for both franchisors and franchisees, with a particular focus on the financing aspects. Do get in touch with Helen if she can be of assistance.