It is essential to make certain that you have adequate capital to not just open your new business, but also to operate your business through break-even.
By Michael Seid, Managing Director, MSA Worldwide
You need to be prepared to make a sizeable investment in the development of any business, and franchising is no different. Some of your start-up costs, like paying a franchise or development fee, may be obvious – while others are less obvious, such as the cost of travel and living expenses while you’re training at the franchisor’s headquarters. It is essential to make certain that you have adequate capital to not just open your new business, but also to operate your business through break-even. And don’t forget that you and your family will also need money to live on, which generally won’t be available on day one.
If the only benefit of becoming a franchisee was an accurate estimate of the costs of developing your business and the knowledge of how much working capital you need until the business can support you and your family, that alone might be worth the cost of admission into a franchise system. The estimated initial investment for your franchise will be found in Item 7 of the franchisor’s Franchise Disclosure Document. But while the information provided to you by the franchisor in their disclosure document is important, relying on that information alone can be a mistake.
- All any franchisor can do is provide you with an estimate of the initial investment you will need to make.
- Market conditions, development costs, and unit operating results will likely be different from what the franchisor projects.
- Use the information the franchisor provides as a starting point; then develop, with your outside advisors, your own budget reflecting how much capital you will really require.
Total investment in a new franchise can vary dramatically, depending on the franchise system you select. There are home-based service opportunities that you can get into for as low as $20,000; there are hospitality investments that can range in the millions. And, while loans and leasing programs are generally available to reduce your initial cash requirements, most franchisors and bankers want to see that you have sufficient liquid assets to invest in the business; because of that, many franchise systems focus on the amount of debt they think is advisable for you to carry. Having sufficient resources to also service your debt is something you will need to estimate.
Be prepared, and be honest with yourself. Rarely is it a good idea to squeeze into any investment and it is never a good idea to misrepresent to yourself, your franchisor, or your banker how much ready capital you have available. Remember, even when your financial projections are based on well-researched performance assumptions, and even when every one of your assumptions comes true (and they rarely do), there may be differences between what you projected and what actually occurs – and those differences may be material. When making an investment in any business, plan for the worst and be prepared. Once you invest, you are on your own; don’t expect your franchisor to come to the table with money to make up for any of your shortfalls.
Let’s look at the types of investments you will need to evaluate in starting your franchise.
The Franchise Fee
The franchise fee that you will pay is the price of admission to the game, but not the price to suit up and play – that will be extra. While franchisors base their fee on how they perceive the value of their brand and what the competition is charging, the fee is meant to offset some or all of the franchisor’s costs in marketing their franchise opportunities to you and others, providing you with initial support such as training and site selection, and supporting your opening with marketing programs and initial field support.
The amount charged for franchise fees will vary; they can range from $0 (which is very unusual) to over $100,000. While the number is not really important, the overall average franchise fee is around $35,000 today.
Rupert Barkoff, a well known and experienced franchise lawyer in Atlanta, Georgia, is a partner at Kilpatrick Stockton. Rupert offers this advice about franchise fees. “When comparison shopping, pay particular attention to what services you will receive for your franchise fee and what other necessary services have separate charges. The lowest, most appealing franchise fee may not be the best value.”
Other Start-Up Investments
In most cases the franchisor is not going to contribute to your cost of opening your business. Some of these costs may include:
- Site Development Costs:
- Costs for finding the right location
- Construction and Leasehold Improvements
- Professional fees for civil and architectural drawings, etc.
- Zoning compliance
- Contractor fees
- Demolition costs
- Furniture and Fixtures
- Freight and sales tax
- Décor packages and signage
- System Security
- Rent Deposits
- Real property and occupancy charges
- Opening inventory and supplies
Management and Staff Training and Salaries
The success of any business is reliant upon how well prepared the owner and their employees are to operate the location. Franchisors will routinely provide training to the franchisee and, more often than not, your key employees and management will be invited or may be required to attend. You should expect that training can last only a few days, but in some more complex businesses, the training may extend for many months. You want to select a franchise opportunity where the franchisor provides you and your staff with a solid base of training in operating and managing your business. Most franchisors also provide you with additional training at your location around the time you are getting ready to open and for a short period after your opening. It is important for you to understand the type and amount of training the franchisor you select will be providing.
The cost of training is generally provided for in the franchise fee, but you can expect to pay for your travel costs, lodging, food, entertainment and other out of pocket expenses. You will also need to factor in the cost of the salaries and benefits you will be paying for your staff attending training and for the time before you open your business.
Legal Fees: In addition to the professional services required for constructing your location, you will also need the services of an attorney to help you negotiate your lease and do all the other legal work required to set up a business.
Accounting Fees: It is important that you start your record-keeping right from the start. Your franchisor may provide you with software or a chart of accounts, and your accountant will help you set up your books and records. Your account can also help you determine how much working capital you will require. Depending on your business, you may need as little as two or three months of working capital or as much as two or three years. Plan accordingly.
Additional costs that you can plan on include, but are not limited to:
- Computer Networking
- Office Supplies and Forms
- Insurance Deposits
- Utility Deposits
- Other Prepayments
- Grand Opening Advertising
- Miscellaneous, for all the things you did not expect
Investment Chart and Item 7 Notes
The franchisor’s FDD will include a chart listing all of the costs that they anticipate you will need to invest as a range, based on their experience. They will also let you know when and to whom those payments will be made. Most important is the information that follows – the notes to Item 7.
The notes to Item 7 will explain each line of the investment chart, giving you information upon which you can localize some of your anticipated costs and upon which you and your advisors can begin to build your business plan. Also, many franchisors will include tidbits of information important for you to know that will not appear elsewhere in their disclosure document. It is important that you understand what the franchisor is saying in the notes to the initial investment chart.
Where you have any questions, call the franchisor and get the information you need. Most franchisors will provide you with the details you require.