Franchising has become a common path in a variety of industries. It can be a tremendous growth engine for the originators of a concept and in turn provides a platform for someone to launch a business. It is not uncommon for a life-long employee to become consumed with the desire to “be their own boss” and a franchise is often the answer to: “But, what?”
Franchisors spend significant time and dollars road testing and documenting their concept, formulas and processes. A qualified and experienced franchisor does an excellent job of eliminating many of the pain points so the process of launching a business is seemingly automated.
However, there is a critical “Must” for all prospective franchisees in considering a business. The most important thing a prospective franchisee MUST acknowledge is that they are participating in a sales process of the franchisor and its representatives.
Franchisors genuinely believe they have THE best concept and they need partners to help grow it. In exchange for the right to use their concept a franchisor is typically compensated by a large upfront fee and a royalty off the top line revenue (generally 5%-8%). Their objective is to open as many “units” as possible. The prospective franchisee’s objective is to launch a profitable business. These are two very different objectives.
Let’s look at a restaurant franchise as an example. The restaurant business is built on strict margins. It is becoming increasingly more difficult to keep food costs at or below 30%. There are also increasing challenges in the labor market with the introduction of the Affordable Care Act and the vigorous debate on raising the minimum wage. If we conservatively assume food and labor costs will consume 65% of the sales while occupancy and overhead will consume 20%, you’re left with 15% of sales. Is this concept worth splitting the 15% operating profit with the franchisor? Well, maybe……..but wait, you haven’t paid the bank yet which will come from your half and the franchisor’s half is guaranteed because it comes off the top – immediately. Oh yeah, you also personally guaranteed the bank debt and the lease. So you have a 50/50 partnership with all the risk exposure and operating challenges on your half. Also if sales dip, the fixed costs will dip into your percentage points. To be fair – if sales excel, additional percentage points will tip your way. In the end the franchisor must have a strong value proposition.
I’ve seen both good and bad franchisors. I’ve also see good and bad franchisees. It takes both. However, the onus is on you – the franchisee – to thoroughly vet the concept and franchisor. From there it is wise to have advisors outside of the franchisor to help you evaluate the projected numbers and the terms of the various legal agreements especially on real estate matters. Frankly, you need an outside advisor that’s going to question the whole idea in the first place. There are so many intangibles to discuss about business ownership that go beyond cost, risk or strength of concept. It is far better to spend some consulting dollars on the front end than being locked into a lofty sales goal with an expensive lease in an industry you know very little about. Maybe a vacation is all you really need.
There was a fair amount of concern over the August employment numbers released last week. The economy added 142K jobs which is a significant drop when compared to the rolling 12 month average of 212K. Furthermore, June and July numbers were revised down by another 28K.
Here are a few additional details in the data release:
- The long-term (27+ weeks) unemployed dropped by 192K down to 3M.
- Professional and Business Services added 47K jobs.
- Healthcare added 34K jobs.
- Food Services and Drinking Places added 22K jobs.
- Construction added 20K jobs.
- Manufacturing was largely unchanged.
- The Average Hourly and Weekly Earnings continued trending up.
While the headline doesn’t read well the details provide a more moderate report. It’s very good to see the reduction of the long-term unemployed and continued increases in average earnings. It’s also good to see the construction sector continue to add jobs for eight straight months. There is no question that we want to see more out of the manufacturing sector in the long-term. However these monthly results are not alarming considering how well June and July performed compared to 2013.
Considering where we’ve been – we should continue to feel positive about the direction of the economy. Anecdotally business owners feel very differently compared to two years ago or even just one year ago. Increased hiring is undoubtedly more widespread across industries and employers of various sizes. We still have our limitations but there continues to be a growing sense of stability and confidence by both business owners and consumers.
With the Summer of 2014 closing out, it is finally time for us to start talking about what everyone has been waiting for all year long – Football.
Well, no, but equally exciting we can start talking about the Tax Extenders. “Tax Extenders” is a package of temporary Federal tax breaks (over 50) that expire and extend every couple years. These provisions expired at the end of 2013.
Since 2014 is a mid-term election year there has been little political courage to see the extension through to completion. Both the US House of Representatives and the US Senate have taken up differing versions of the legislation. The House version attempts to make some key provisions permanent and the Senate version, referred to as the EXPIRE Act, attempts to give all provisions a two year extension. Both efforts were officially stalled several months ago in favor of waiting for the November election results.
Below are some key provisions that have widespread applicability that we should hope to see extended:
- Qualified Restaurant Buildings, Retail Improvements and Leasehold Improvements – $4.8 Billion (10 Year Cost) – Restaurant operators have the ability to recover their real estate investment over a 15 year depreciable period rather than the default period of 39 years. Other similar provisions would also benefit a retailer’s improvements to real estate and a lessee making qualifying leasehold improvements.
- Bonus Depreciation – $2.85 Billion (10 Year Cost) – Bonus depreciation allows for a 50% immediate write-off of qualifying property. When coupled with a cost segregation study this provision can be a major incentive for companies to not only purchase new equipment but perhaps expand their facilities.
- Increased Limit to IRC Section 179 Expensing Election – The expensing election for qualifying equipment reverted back to its $25,000 limit on January 1, 2014. Increasing this limit has become part of the Tax Extenders. The extenders version raises the limit to $500,000.
- Research & Experimentation Tax Credit (R&D Tax Credit) – $16 Billion (10 Year Cost) – This has wide-spread applicability to businesses that are willing to invest in the betterment of the science of their product. Qualifying start-ups may benefit from a payroll tax credit.
- Work Opportunity Tax Credit (WOTC) – $3.16 Billion (10 Year Cost) – Employers are incentivized through this tax credit to hire qualifying individuals that are on living assistance, unemployed or disabled veterans or ex-felons.
- Energy Efficient Commercial Building Deduction (179D) – $304 Million (10 Year Cost) – Real estate owners willing to invest in energy efficient systems (lighting, HVAC, etc.) that increase the efficiency by at least 50% can benefit from a deduction of up to $1.80 per square foot. This extended version of the law does increase the efficiency requirements from prior years.
- New Market Tax Credit – $1.8 Billion (10 Year Cost) – This is a major tool in the development of targeted markets that incentivizes private investment through the award of tax credits. When these tax credits are administered through a non-profit development corporation that has a large scale (multi-year) strategic plan of development they can really make an impact on a city and its economy.
This is just a sample of the provisions covered in the Tax Extenders. Most of these provisions have had support from both sides of the aisle. So while these provisions become a politically charged topic in an election year, we’re nearly certain to see an extension in some form regardless of the election results. In the past when we’ve seen expired provisions extended it has been applied retroactively to eliminate the gap. We’ll be following these developments closely but the variables should be factored into your year-end plan currently. You may need to add a few if/then statements to your formula….