Buying a franchise: put the franchisor’s profit forecast to the test

A strong brand and an impressive forecast are not the same as a profitable business. When you buy into a franchise network, you need to investigate what the projected earnings are based on and whether the figures reflect the day-to-day reality of running your business. The aim is not to predict everything, but to understand which assumptions must hold true for the investment to make sense.

1. Establish what the figures actually show

Start by identifying what each set of financial information represents: historical accounts for a specific outlet, an average across several outlets or an illustrative budget? A spreadsheet with precise figures may still be based on estimates.

Ask for an explanation of the basis for both turnover and profit. In particular, check:

• What period do the figures cover, and do they capture a full year of seasonal variations?
• How many outlets are included, and how were they selected?
• Are the outlets new or well established?
• Are both franchisor-owned outlets and those run by independent franchisees included?
• Have closed or loss-making outlets been excluded?

An average can conceal substantial differences. Ask to see the range of results across comparable outlets too, in anonymised form if necessary. The information is more useful if it includes their size, location and how long they have been trading.

Next, check how profit is defined. Terms such as ‘operating profit’ and ‘earnings’ do not, on their own, tell you whether the owner’s work, depreciation or finance costs have been taken into account. Ask for a breakdown showing how turnover translates into the final profit figure.

2. Adjust the figures to reflect your own operation

Historical figures need adjusting before you can use them to make a decision. For example, a franchisor-owned outlet may have administrative tasks handled by head office without the full cost appearing in the outlet’s own results. Your business may have to pay for those same tasks directly.

Work with an accountant to check that the forecast includes all relevant costs: staffing, holiday pay and pensions, stock losses, payment processing, cleaning, maintenance, administration and the payments required under the franchise agreement. Also check that turnover and costs are treated consistently for VAT purposes.

Put a realistic value on your own work. If you operate as a sole trader, personal drawings are not a wage expense in the accounts. That does not change the fact that the business needs to be able to reward your work financially. Prepare a separate calculation that includes reasonable remuneration for you as the owner, regardless of the business’s legal structure.

Also distinguish between profit and the ability to meet payments. Loan principal repayments reduce cash flow but are not an operating expense in the profit and loss account. Depreciation, by contrast, affects profit without necessarily involving a payment in the same month. Ask your accountant to show both perspectives, so that a positive operating result is not mistaken for cash you can freely withdraw.

3. Test turnover from the bottom up

Do not simply adopt the franchise network’s projected annual turnover. Instead, build a local forecast based on the conditions in which you will actually operate.

For a shop, you could start with the number of purchases per trading day and the average transaction value. For a service business, you could use the number of billable hours and average revenue per hour. Then check whether staffing, premises and opening hours provide enough capacity for the assumed level of activity.

Ask three specific questions:

1. What customer base is needed to achieve the projected sales?
2. How quickly are new customers expected to arrive and return for repeat business?
3. Which costs will increase as activity grows?

Then prepare a base case and a more cautious scenario. In the cautious scenario, the start-up period might take longer, the average transaction value might be lower or staffing requirements might be higher. Choose changes that make sense locally, rather than applying an arbitrary percentage reduction to every figure.

Also calculate the turnover needed to cover costs, including your desired remuneration. If this requires almost full capacity from the outset, scrutinise the assumptions particularly carefully.

4. Understand the rules and make uncertainty visible

Denmark has no specific franchise law, no mandatory franchise-specific disclosure document and no separate requirement to register franchise agreements with a public authority. You will therefore not automatically receive standardised earnings information before signing.

The Danish Contracts Act and general principles of contract law apply, while legislation such as the Danish Marketing Practices Act and competition rules may also be relevant. General principles concerning the duty to disclose information in good faith may require material facts to be disclosed. Depending on the circumstances, incorrect or misleading information may give rise to liability or other contractual consequences. A disappointing result, however, does not in itself establish grounds for a legal claim.

Finally, draw up an overview with three categories: documented figures, reasoned estimates and unresolved issues. Have your accountant assess the calculations and your lawyer assess the significance of any earnings claims and liability disclaimers.

Practical takeaway: Do not buy on the strength of a single profit figure. Buy only once you understand the underlying data, have factored in the value of your own work and can explain why a cautious local forecast still stacks up.