Franchise Finance Part I: The Costs of Buying and Running a Franchise
As a prospective franchisee, franchise financing is probably one of your top concerns. At this stage, you’re probably preoccupied with sourcing finance. But before you race off to woo your banker, or sign over your life savings to your franchisor, do you understand what you’re getting yourself into? Read on to find out more about the costs of buying and running a franchise…
What is a franchise?
A franchise is a business concept that offers specific products or services and takes on a certain business identity. The business concept is usually repeated numerous times throughout an area by franchisees purchasing and running their own franchise in a specific area as determined by the developer of the concept (the franchisor).
How do franchises make their money?
Franchises make their money from collecting franchise fees, start-up fees and franchise royalty fees from you, the franchisee. So what’s in it for you? Well, your investment acquires the rights to an established business name and proven business system, along with business support and training.
What is a franchise fee?
This is the initial upfront fee to the franchisor, or the cost of buying into the franchise system. Your franchise fee includes the rights to use the franchise branding, training, procedures and franchise manuals. The franchise fee is usually due once the franchise contract agreement has been signed but can also be a fixed fee on a sliding scale.
What is a franchise royalty fee?
This is the price you pay to stay in the franchise system; on-going payments which franchisees must make to franchisors, usually based on a percentage of sales.
Set-up costs for a franchise
In addition to franchise fees and on-going franchise royalty fees, you will need starting capital to finance the purchasing of stock and supplies, marketing and advertising materials and kitting out your premises – clarify with your franchisor which of these costs are not included in your initial franchise fee. Don’t forget that you will also have to pay rental deposits, deposits for utilities and costs for hiring staff, amongst other things.
It’s going to take a while before your new franchise starts turning a profit – anything from a few months to a few years. Until then, you will need a tidy sum of money to keep you in business, and pay your expenses. Working capital is the cash you have available to you for the day-to-day running of your business. Ask your franchisor to provide you with an estimate of the amount of working capital you will need, or speak to other franchisees in your franchise system.
There’s no getting away from this one; you will need to factor legal fees into the equation, as well. Find a franchise lawyer to scrutinize your franchise agreement contract, and to negotiate the franchise terms and conditions, to secure you the best possible deal. Ensure that you fully understand the terms and conditions of the franchise agreement, including which fees are applicable and when, and the costs for which you are responsible and those for which your franchisor is responsible. Money spent now will prevent misunderstandings or disputes – and possible costs incurred to you – down the line.
Now, that you have a better idea of what costs you’re in for, you can plot your next step – how to finance a franchise.