Welcome to this first edition of the whichfranchise.co.za newsletter for franchisors. We will use this monthly newsletter to provide you with information on franchising in the widest sense of the word, covering how to start one, how to grow it and how to operate it in such a way that it becomes the leader in its sector.
In addition to this version of the newsletter, we publish a separate version geared to the needs of prospective franchisees. Although the two editions will generally be different, a certain amount of overlap will on occasion be unavoidable. The reason for this is that the fortunes of franchisors and franchisees are closely interlinked.
In addition to featuring news of general interest to franchisors, this newsletter plans to serve as a forum for the exchange of ideas of concern to the franchise fraternity. Seeing that the decision of a Cape tax court judge to label royalty payments as capital expenditure could have dramatic consequences for the franchise sector, we considered it appropriate to deal with this topic in our first edition.
Future editions will feature developments in franchising in South Africa and around the world. We will also keep you informed of franchise-related events. However, this is your newsletter and we hope that its content will be shaped by you. We therefore invite you to ask questions and provide commentary on franchise-related topics that concern you, or a member of your network.
Within the framework of experts@whichfranchise.co.za , our panel will respond to every email personally, usually within 24 hours. This means that you have access to a panel of mentors at no cost or obligation. Future articles will largely revolve around the questions you ask and the opinions you express, be it in response to articles we carried in a past issue or relating to a new topic you wish to raise. So, start sending us your emails!
SARS' take on royalty payments
Interest in international franchising growing
whichfranchise.co.za off to a flying start
The International Franchise Expo, which took place in Washington , USA earlier this month, provided a new take on international franchising. For three days, representatives of corporations and individual entrepreneurs alike filled the halls. Visitors were drawn from all corners of the globe, with over 40 countries represented. Put differently, these foreign visitors made up 25% of the total attendance figure, a significant increase from the 1992 event when foreign delegates accounted for a mere 5%.
Franchise expert Philip Zeidman, a lawyer who has witnessed franchising's growth over the past 2 decades, comments that with the US market moving towards saturation, international expansion is the next big thing for America 's franchisors. He cites the example of China where 109 cities have populations exceeding the one million mark. More importantly, per capita income is rising and a growing number of people now have disposable income.
Tempting as this may sound, however, there is no need for South Africa 's franchisors to set their sights on China just yet. Our own continent offers an ever-growing number of attractive destinations. In addition to Egypt and Morocco , both countries that have shown interest in South African franchise opportunities in the past, Nigeria had a delegation in Washington and is clearly ready for action.
Anayo Agu, a trade specialist working with the Nigerian Commerce Department, said that Nigerians are looking for opportunities to invest in franchises. “A negative perception of the prevailing business environment in Nigeria may have been a barrier to business some years ago, but this is no longer realistic,” he says.
And a report published in the Nairobi-based The East African newspaper, although dealing with commercial failure, points towards the fact that Kenyan investors see franchising as something of a magic wand. The owners of Uchumi, an ailing chain of retail stores, grew tired of losing market share – and money. They fired their CEO and replaced him with a guy who wanted to use the franchise model to turn the company's fortunes around.
So far so good, except for the small matter of insufficient money and expertise. Unfazed, the enterprising manager listed the company on the Kenyan Stock Exchange and raised $16,6 million without any problems. Although this was insufficient to end Uchumi's woes, it shows that investors everywhere have an almost naïve belief in the power of franchising.
South African franchisors with the necessary infrastructure in place to support a soundly structured venture in a foreign country will be well advised to investigate the potential of this market for their brand, keeping in mind that their offerings must fit the target country's culture.
For less adventurous franchisors, South and southern Africa continue to offer outstanding opportunities. Incidentally, this is no longer one-way traffic, as the most recent edition of FASA's newsletter ( www.fasa.co.za ) reports. They give the example of Buddy Msibi, a director of Swaziland 's Tile King, who plans to drive his company's growth through franchising. In addition to offering opportunities throughout his own country, Buddy is targeting prospective franchisees in Durban , Nelspruit and other towns in the area. This is to be welcomed because competition makes the market grow and we wish Buddy luck with his brave venture.
In keeping with world-wide trends, international expansion is the next big thing for South Africa 's franchisors. As a service to our readers, we will research this topic and discuss it more fully in the near future.
Last year's landmark ruling by a Cape Tax Court, which agreed with SARS that royalty payments are capital in nature and therefore do not constitute a tax-deductible expense, continues to exercise the minds of franchisors and their professional advisors. Although many experts believe that the learned judge erred in his findings and are convinced that SARS will lose its case if and when the matter goes on appeal, court decisions are notoriously unpredictable and taking the proverbial ostrich approach is unlikely to make the problem go away.
As matters stand, it will be prudent to ensure that franchise agreements entered into in future reflect the true situation as far as “royalty payments” are concerned. We have used inverted commas advisedly, because in the franchise relationship, the term ”management services fee” reflects the true nature of the payment with far greater accuracy.
This is more than a case of semantics. In return for collecting ongoing franchise fees, franchisors are expected to provide extensive ongoing support. Once this fact has been internalised, it becomes self-evident that the royalty portion constitutes but a small portion of the total franchise fee. As long as your franchise agreements contain a list of the services you perform for franchisees, and a breakdown of the costs attached to each service component, franchisees could, at worst, face a demand by SARS to treat the actual royalty portion of the fee as capital expenditure.
Seeing that in every bona fide franchise operation, the lion share of the franchise fee is allocated to franchisee support, the residual tax liability would be reduced to a minor irritation. But what about franchise agreements that are already in force and describe the full ongoing franchise fee as “royalty”? Fortunately for those franchisors who allowed this to happen, the law permits existing legal agreements to altered retrospectively provided that the parties can show that the change reflects reality.
In other words, if you can demonstrate that you provide substantial ongoing support to your franchisees, you have every right to amend existing franchise agreements to reflect this. Depending on individual circumstances, you could allocate, say, 4% to ongoing support and 1% to the right to use your network's brand and intellectual property. The worst-case scenario would then be that your franchisees cannot treat the 1% as a tax-deductible expense.
It's important to note, however, that to withstand scrutiny by SARS, such an allocation cannot be made arbitrarily. It must reflect actual practice and be supported by verifiable facts and figures.
We advise you to seek the assistance of an experienced franchise attorney who will, firstly, amend your network's franchise agreement for future use. Secondly, he or she will draft an amendment to your existing agreements that will protect your franchisees' legitimate interests vis-à-vis SARS. This attorney will know that it is essential to use the term “management services fees” to describe ongoing franchise fees, and that a proper breakdown of how these fees will be applied is given.
The article Are royalty payments tax-deductible? located elsewhere on www.whichfranchise.co.za deals with this topic some more. And Succeed magazine will publish an in-depth article in July, so look out for the next issue of this excellent magazine.
While most franchisors pay lip service to the notion of operating a representative body made up of franchisees, the jury is out on how successful these structures really are. We would like to know how many of you have active franchisee representative bodies in
place, what their rights and obligations are and how they are organised. Most importantly, do they really contribute to the success of your networks? We hope to initiate debate on this topic that could eventually lead to workable guidelines for the franchise sector to follow.
Following the launch of whichfranchise.co.za during Franchise Week 2006, we had the pleasure of fielding thousands of enquiries from people who wanted to know what we are all about, and how we can help them to advance their franchise plans. During the month of May alone, we had 16 828 pages accessed on our website.
As we expected, questions received from prospects revolve primarily around franchise opportunities, how to locate them, how to evaluate them and how to fund them. We made a point of answering every question, usually within 24 hours. We expect the momentum to grow over the next few months and before long, whichfranchise.co.za will be a household name in franchise circles. This will prompt a growing number of prospective franchisees to visit, and franchisors wishing to expand their networks simply need to be represented. Keep this in mind when you allocate your marketing funds.
Whichfranchise is pursuing various opportunities to market the website, including a presence at the Franchise & Business Opportunity Expo scheduled for 7-10 September. We will feature advertising franchisors prominently at our exhibition stand. Watch this space for more info on marketing activities.
In our next issue, we will highlight the core topics we plan to address in the next few editions. In the meantime, you can find out more about this site and our exciting plans for the future by contacting Anita at anita@whichfranchise.co.za.