How to figure out start-up operating costs

For anyone thinking of starting a new business, determining how much capital will be required is the most critical piece of information they will need. Besides the initial investment for land, building, furniture, fixtures, and equipment, the new business owner will need to purchase inventory and supplies and a host of other essentials just to get the door open. But, having enough money just to open up will usually not be sufficient. They will also need money to keep the business up and running until it begins to support itself. Running out of working capital is probably the single biggest cause for new business failures. If the only benefit you received from joining a franchise system was the information needed to project how much capital you would need, paying the initial franchise fee would be worth it.

Without the knowledge that comes from a mature franchisor, small business owners would need to research equipment suppliers, work with architects and décor designers, determine site requirements, locate vendors, and on and on. But without a base of reference and advice from someone who has gone through the process before, locating all of the resources they will require will take time. And, for new business owners, time is a very expensive commodity.

Franchising provides two resources for determining start-up costs for new franchisees:

  1. The existing franchisees in the system. Franchisees that have recently developed new locations can provide real-time estimates of what is required. Even with information provided by the franchisor, smart new franchisees will talk to other franchisees to confirm what the franchisor has estimated.

  2. Item VII in the franchisor’s FDD. Every franchisor is required to prepare and deliver to prospective franchisees a copy of their disclosure document – the FDD. Within the FDD the franchisor is required to estimate the initial investment each franchisee will require – including the working capital they will need during the early months of operation.

Whether you plan to open up an independent business or a franchise, with the exception of the franchise fee and other costs unique to franchising, new business owners should be prepared to estimate, among other items:

  • The cost of finding the location: Even if the landlord pays the real estate agent’s commission, you will probably incur the cost of research on the market including demographics, traffic studies, and your competition.

  • Security deposits: Expect everyone to look for you to give them a security deposit – the landlord and the utilities will probably be the first to ask.

  • Professional fees: Building or even remodeling an existing location is going to require architectural plans. In addition to architectural fees, plan on spending some money on engineers as well. If the site is not zoned for your type of business, lawyers and other professionals may be required to help you with the zoning board.

  • Getting the site ready: There will be costs for finding the contractor, building and equipping the location, acquiring signage, furniture, and décor packages, and landscaping the exterior. Everything you put into the site will probably come by truck, so plan on freight costs and sales tax as well.

The location may be ready for occupancy, but you still have a bit more to go:

  • Opening Inventory and Supplies: Raw materials, paper supplies, cleaning supplies, smallwares, and everything you will need to prepare your products or services.

  • Insurance: Not just property and casualty insurance, but worker’s compensation and, if you have a vehicle, auto insurance as well. Plan on your insurance broker asking for all or part of your first year’s premium as a deposit, in advance.

  • Point of Sales and Computer Hardware and Software: Every business today, no matter how small, is going to require a certain amount of computer power. If you can’t find software that’s right for your business, plan on professional fees to develop customer software for you.

  • Other Professional Fees: In addition to your architectural and engineering fees, you will likely need a lawyer and accountant to help you establish your business, negotiate with the landlord and zoning board, etc.

  • Pre-opening labor: Labor costs don’t start the day the first customer walks through the door. You will need to hire managers and staff before the business opens to help you set up the business and to attend any training classes that they must attend.

  • Working Capital: Working capital is the amount of money you need on hand to pay bills to the extent that they are not covered by the cash that comes in. Depending on your business, you may need working capital to get you through the first few weeks, but many businesses require additional capital well into the first two or three years.

You can hope for the best, but plan for the worst. Make your plans based upon realistic expectations, not pie-in-the-sky wishes. While the franchisor will project your opening capital requirements in their FDD, these are usually based on system averages. Your location will likely be different in some way from the average. It may be a larger site in a more expensive area, or possibly your labor costs or sales will be different than the franchisor expected. Smart franchisees investigate the costs in their area and modify the franchisor's projections based upon the reality of their markets. Don’t blame the franchisor if you do not do your homework.

Starting a new business is a stressful time. If you plan well, it can also be one of the most exciting and rewarding times.

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“I have known Michael for almost 20 years and he is as knowledgeable about franchising as anyone in the industry. His approach is pragmatic, creative and strategic. When I need guidance or advice in franchising, I go to Michael."

Peter Hoppenfeld, Principal
Peter Hoppenfeld, Attorney At Law
 

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