How do you know if you have enough money to not only buy a franchise but to actually run it? We frequently hear about new franchisees who were undercapitalized when it came to running their businesses. They had enough to finance the start-up, and they thought they had enough to get them through the early months before they earned a salary, but it took longer than they thought to breakeven.
Along with financing the start-up of your new franchise business, it’s important you have enough liquid capital to run the business until it starts generating positive cash flow. So, while you’re researching different franchise opportunities, you might want to ask franchisors and current franchisees how the corporate office ensures new franchisees have enough money early on. Keep in mind, some brands offer financing support for new franchisees during the first year of business.
We also urge you to carefully consider the financial documents within the franchise disclosure documents (FDD) and talk to existing franchisees about what you should realistically expect in terms of how long it takes to be profitable.
Item 7 in the FDD can help prospective franchisees make sure their franchisor is realistic and upfront about expenses involved in the business. That said, all Item 7s are not equal. Some franchises outline the necessary working capital, but others—who might want to keep the stated investment level as low as possible— don’t. Any investor should understand and plan for the fact that it might cost three to four times more to actually run the franchise business, as compared to the financial estimates listed in the Item 7 of the franchise company’s FDD.
Where possible, all potential franchisees should also thoroughly review and understand a company’s Item 19, if included, so they have a better idea of what to expect in the way of gross revenues and profitability. Not all franchise companies provide an Item 19 as part of their FDD because it’s not required, and, like the Item 7, every Item 19 is different. It is critical that you truly understand what you’re looking at within the Item 19. It’s up to the franchisor how detailed they get or which franchisees’ financial information they include, so you want to make sure that you’re looking at a good representation of all the franchisees and what they earn and spend.
Running a successful franchise requires a lot more than just covering your franchise fee and opening your doors on Day 1. You need to make sure you’re in the financial position to still be opening your doors on Day 366, Day 730, and well beyond. Make sure you do your research upfront to know what you’ll need to get there.