Advice & Tips Ask an Expert November/December 2022 Previous Issues

Q: When is the right time to expand my franchise? 

From a financial perspective, there are several important factors you should consider when deciding whether it’s time to open your next franchise location. 

Ensure existing operations are strong, and you have the numbers to prove it. Are your operations continually disrupted by staff turnover, product outages, or changes in suppliers? When your systems, processes, and teams are operating smoothly, those efficiencies translate into steady revenues, optimized gross margins, and strong key performance indicators (KPIs). 

In fact, more and more financial institutions are moving away from looking strictly at traditional debt-to-earnings ratios and are performing deeper investigations into KPIs that tell the story behind the numbers. 

Financial KPIs may include times-interest-earned, or how much of your production is wasted versus sold, whereas non-financial KPIs include an operational component, such as revenue per seat (measuring the amount of sales per customer) or days in inventory (the ratio of days inventory is held before it’s sold).

Consider your current financial position. When considering expansion, don’t just look for cash-on-hand and a decreasing debt balance to support the initial investment. Consider whether you’re ready to take on a new financial commitment and how you could support any unforeseen capital costs or initial working capital requirements.

Most new franchisees would benefit from having additional working capital earmarked to support the start-up phase through either savings or a combination of savings with an affordable line of credit. 

Lean into your franchisor’s mentorship and advice. While the level of support franchisors provide varies by agreement, strong communication with your franchisor around expansion goals can encourage a clear path to guidance and mentorship. You are, after all, deepening your commitment to the brand and the business.

Additionally, ask your franchisor to connect you with other multi-location franchisees within your brand — preferably those in your area or location type (rural, urban, or suburban). They may be able to provide you with the insight needed on what franchise expansion would look like for you at a granular level. 

Conduct market research. Franchisees may not always have the ability to make decisions around new locations or market placement, but market research will help you understand how your concept will work in other locations, learn what potential competitors are doing, and find out what makes an ideal location for your franchise. Franchise consulting companies can provide invaluable and expert industry insight, while local commercial realtors can be helpful when evaluating and negotiating the right space and lease agreements. 

Evaluate your supply chain thoroughly. In times of continued disruption to the global supply chain, franchisees should consider realistic timelines for long-lead equipment, the timing of lease commitments, and cost projections for the ideal location. This level of advance planning can mitigate risk for franchisees, lenders and investors, and the brand as a whole.  

Consider your financing structure. While the traditional route for financing is often to purchase with debt through a bank, weighing the cost of interest against your bottom line in today’s environment of rising interest rates is crucial to ensuring you have the right balance of debt to leverage. 

You could, for example, offer a percentage of ownership to those who may be personally invested in the business (like the general manager of your new location) in exchange for capital financing. A unanimous shareholders’ agreement could be structured with agreed-upon terms that allow for flexibility with profit-sharing and buy-out clauses. Diversifying your sources of financing through a combination of equity and traditional debt could provide the flexibility to grow and develop operations without becoming burdened by interest and loan repayments. 

Expanding franchise operations is a major step. Whenever you’re making significant financial decisions, it’s always beneficial to connect with your network to ask the right questions. Speaking with your accountant and financial advisors will help you understand your company’s current financial position and performance, by identifying and measuring the KPIs that will move you toward your expansion goals.

Lauren Carlos, CPA, CA
Manager, Private Enterprise