Financial Questions to Ask Yourself Before Buying a Franchise

Buying a franchise is an important decision that will impact

you financially. Each franchise business comes with financial obligations that include startup costs and ongoing expenses. Because of these potentially large price tags, you need to ask yourself specific financial questions before buying a franchise.

How much initial investment will you need to buy the franchise?

Your startup costs can include a franchise fee, an initial cash investment, professional fees, insurance, employee training, operating licenses, inventory, equipment, and the expenses involved in running a retail or office space, such as moving expenses, furnishings, equipment, decor, signs, and landscaping.

With the franchise fee, you are basically purchasing the rights to the franchisor's trademarks, business methods, and distribution. The amount, which typically ranges from $10,000 to $30,000, chiefly reflects how established and well known the franchisor is and the size and location of the franchisee's territory or trading area. Sometimes the franchisee can arrange to pay the fee in installments.

Other costs you may encounter besides the initial franchise fee are training expenses, startup promotional fees, inventory, specific architectural elements, equipment, fixtures, and any other expenses necessary to open your business. Be wary: franchisors often underestimate the initial expenses in an effort to make the franchise appear more favorable as a possible investment. This could leave you with insufficient funding later on when you have to meet your ongoing expenses. To keep this from happening, you should do your own cost analysis of these initial expenses, particularly with respects to real estate and construction renovations.

What are your ongoing expenses until the business starts showing a profit?

Ongoing expenses generally include paying royalties to the franchisor, advertising fees, equipment maintenance, employee costs, insurance, rent, and inventory. The royalty fee can range from 1 to 15 percent of your gross sales with the average being 5 percent. Because it is based on gross sales rather than profits, it can be a burdensome expense. Rather than a royalty fee, some franchisors charge a regular fee due weekly, monthly, or quarterly.

Every business has a period of time before it starts to make a profit and pay for itself. Depending on the type of business, this can be anywhere from two months to two years and you need to plan accordingly. It’s better to make your estimate high rather than low. Having too much money for ongoing expenses is preferable to coming up short of cash and having to deal with the problems it causes.

How much available cash do you have to put towards the franchise?

You need to evaluate the assets you have available to meet your initial and ongoing expenses. In addition, franchisors require their prospective franchisees to have a certain net worth going into the venture. The easiest way to determine your available cash is to develop a business plan.

As you determine the cash you have available to invest in a franchise business, remember that you still have to pay your living expenses until the business begins to show a profit. Lenders do not like you to use more than 75 percent of your cash reserves because more than that limits your ability to deal with unexpected problems, both within the business and your personal life.

What financing can you get to make up the difference between your expenses and cash investment?

Once you determine how much you can personally contribute toward paying your expenses, then you need to look at ways of financing the remainder. Because you are beginning a new business, lenders will want the loan backed by collateral or guaranteed by an agency such as the Small Business Administration (SBA). For more information on these options, be sure to read Funding Your Franchise.