One of the first questions people ask themselves when they consider purchasing a franchise is ‘How much does the franchise cost? Initially restaurants are attractive due to their brand appeal, but most people eventually eliminate it from consideration once they discover a comparatively high initial expense and operating costs. Everyone has a different personal worth and it is important to determine what franchises are in their price range before continuing the exploration process.
When it comes to first time business owners there is a tremendous amount of misunderstanding about the true cost of purchasing a franchise. Not being able to attain an accurate figure for a franchise can be a frustrating experience and cause people to look at other options before continuing their due diligence. I recommend to people that they should know their general investment range before exploring franchises. Essentially they should pre-qualify themselves for such investments.
When people start researching restaurants, their first reaction is often that franchising is expensive. The reality is franchising is not expensive – restaurants are simply on the higher-end of the scale. People may also find a particular franchisee fee online and feel optimistic that is falls within their price range. However, when they speak to a franchisor’s sales representative, it can be equally disappointing to learn there is a higher cost associated with purchasing the franchise along with a certain amount of debt to carry that comes with it. In this case, it is important to understand both how much cash you need to purchase a franchise and the total actual investment.
To figure out the total actual cost of a franchise investment, I recommend examining the franchisor’s Franchise Disclosure Document. Item 7 of the FDD is titled Estimated Initial Investment, which is a comprehensive list of expenses you can expect to incur when opening a business. This figure includes the total amount of money that is required to open the business, along with a cash flow amount for at least the first three months of operation. A good resource to find FDD’s for free is www.fddexchange.com.
In addition to reviewing the Total Initial Investment found in Item 7 of the FDD, there are two other important areas to consider in order to get a better understanding of the personal affordability of a franchise. One factor is the amount of money needed to operate the business until it starts to make money. This is the total operational cash flow requirement. There will be an initial negative cash flow as more money is put into the franchise than what comes out. Potential franchisees must determine approximately how long it will take to reach a break-even point between investing initial expenses and finally making money.
Another calculation to be aware of is a personal cash flow requirement. This is the amount of money it will take to run your family from the time the business is getting off the ground to the point in which the business can cover your family’s expenses. Nobody wants to start a business and quickly find themselves in personal debt because they did not take into account this important factor.
Once one determines the initial investment, the amount of cash flow needed until the business breaks even, and the personal cash flow requirements, then the process of financing can be examined. Many franchises can assist with putting people in touch with banks or preferred lenders they have worked with in the past.
Fundamentally, there are two types of financing categories – debt financing and equity financing. Traditional debt financing involves the repayment of principle and interest over time. Normally collateral is also required. An SBA loan is the most common type of financing. While the Small Business Administration helps by approving franchise systems, in actuality, the SBA plays a secondary support role, acting primarily as a loan guarantor for the lender.
Whereas debt is the exchange of money for a promise to repay, equity financing is the exchange of money for ownership. This can happen in the form of personal cash, investors, partners or, a ROBs program. Equity financing does not require collateral and there is no repayment. However, you will give up ownership in the business. The investors receive stock (equities) in exchange for their investment and are entitled to a portion of the profits. Equity financing can be an appealing option for some people depending on how much ownership one has to give up.
The cost of a franchise is often directly related to the amount of infrastructure that needs to be put into place before opening and there is a wide variation. Restaurants, with large square footage, supplies and equipment, are generally more expensive. Fortunately, there are many less expensive franchise options. These are franchises that can operate from home or office locations and have low investment and operating costs.
There are many details to know about buying a franchise, and perhaps the most intimidating aspect is the cost associated with the purchase. One of the first steps people should take in making a sound investment is understanding the true amount of money needed to purchase the franchise and that it ultimately fits within their price range.
Rick Bisio is a leading franchise coach with FranChoice, the creator of the FDD Exchange and the Franchise Glossary and the co-host of Rick Bisio’s Franchise Focus. Since becoming a franchise coach in 2002, Bisio has assisted thousands of aspiring entrepreneurs nationwide explore the dream of business ownership.