Understanding Costs in Opening a Franchise Business

Franchises are business models that have been tried and proven several times before being taken to the next level. As a franchisee, obtaining access to that system provides you with the potential to begin operations more quickly, to spend less money initially, and to steer clear of common pitfalls.

Most franchise companies will give you comprehensive training before you open your doors, including everything from site selection and build-out to employee recruiting and training, customer service, and management. In addition, the majority of franchisors consider this training to be only the beginning of the process.

The fees associated with purchasing a franchise for your company will typically vary anywhere from $18,500 to $84,500.  However, there are many costs beyond just the franchise to get a franchise up and running.

The actual prices that you spend will vary depending on the franchise team that you are working with, the business sector that you are operating in, and the amount of assistance that you need.

The following is a breakdown of the estimated costs associated with the various stages of the process of opening a franchise, including the formation of your new franchise company, the preparation of financial statements, and the registration of the franchise. Here’s what we’ll cover:

Costs Associated with Opening a Franchise

When it comes to franchise prices and fees, there is a wide variety of terminology that is often used in the franchising industry. 

When beginning and expanding your new franchise company, you will need to have a solid understanding of the one-time starting expenditures as well as the regular recurrent charges that will be required of you. This is true of any new business. 

If you have a solid grasp of “the numbers,” it will be easier for you to assess the kinds of enterprises that may or may not be within your financial means. 

This article will assist you in gaining a better understanding of how your money may be invested most profitably by providing a breakdown of the usual expenses associated with purchasing and running a franchised company.

3 Most Important Costs of Franchising

There are three primary types of expenditures associated with purchasing a franchise that you need to be aware of as a potential investor in a franchise company. These are the following:

The Franchise Sum

These are the first franchise costs that you will be required to pay in order to get permission from the franchisor to run their company for a certain amount of time. This is basically “the cost of entry” to utilize the brand and business processes that are provided by the franchise corporation. It is a one-time fee that must be paid upfront in a lump sum in order to start the process of building and opening your franchise. This means you will not have to pay it again once you pay it the first time.

The initial franchise fee for purchasing a franchise goes anywhere from $25,000 to $50,000 or more. There is a lot of variability in franchise fees across franchises, with some being quite high. You’ll want to consider this in your analysis when deciding what franchise is appropriate for you.

Oftentimes, the initial franchise fee can be financed and then paid for over time.

Startup Expenses

These are the upfront costs that you will pay in order to have your new company up and running and ready for customers. Initial investment requirements might vary greatly from one franchise opportunity to the next. 

There are both high- and low-cost franchise opportunities available, with some requiring less than $20,000 to get started while others need several million dollars. 

Due to the lower expenses associated with real estate and buildout, service firms often have lower startup costs than retail or food-related enterprises. According to the findings of Franchise Firm Review, the typical investment for a franchised business is $150,000.

The startup costs of many franchises can stretch into the high hundreds of thousands and even the millions. For example, opening a new McDonald’s franchise can cost anywhere from $450,000 to $2.5 million, depending on the location and other factors associated with starting a new storefront. This is not a small cost by any means.

There are also many franchises that have much cheaper startup costs. However, remember, the lower the startup costs, the more likely it is that the franchise generates substantially lower revenues and potential profits. Franchisors know the value of their franchise and will leverage it accordingly so that the startup cost is just right.

Recurring Fees

In addition to the franchise fee and your initial startup costs, all franchise companies charge ongoing fees in exchange for a variety of benefits that will be provided to you as a franchisee. These fees are paid in exchange for the opportunity to become a member of the franchise system. 

Royalty costs, advertising and marketing fees, technology fees, and other day-to-day fees are generally included in this category. A good portion of these recurrent charges will be dissected in a later section of this paper.

These recurring fees are typically charged as a percentage of your franchise location’s gross monthly sales. Franchises will list these fees on their brochures and informational materials. In general, these fees tend to be pretty consistent across franchises, but there may be some slight variability between brands overall. In general, this is the least variable of the three categories listed.

Candidate’s Financial Requirements

Most franchisors demand that franchise applicants satisfy specific budgetary and net worth standards. In most cases, they will establish minimums for both liquidity and net worth, although these will differ from one brand to the next. This is how they ensure that franchisees are financially stable enough to support their business, thereby increasing the odds of success. Remember, it’s not only important for you that the franchise succeed but also for the national brand, as having locations close hurts their revenue and their image with customers.

Liquidity

Since it will take some time before you start turning a profit, the majority of franchisors require that you have a certain minimum amount of liquid assets (an asset that can easily be converted into cash in a short amount of time) on hand to cover any costs that may arise in your first year of business. Liquidity requirements vary across franchises and usually rise as the initial startup costs of the franchise rise.

Net Worth

Franchisors will look at your net worth to make sure you have the financial security to take on the challenges of running your own business. You are making an investment in the brand, but the brand is also making an investment in you, and it wants to know that you are a solid contender for the ownership of the firm. Like liquidity requirements, net worth requirements typically rise as the initial startup costs of the franchise increase.

Costs Involved in the Preparation of Franchises

When you first begin your road toward being a franchise owner, two of the most important partners you may have been a franchise lawyer and a company accountant. These individuals will help you make sure that you have all your ducks in a row before starting up your franchise.

Franchise Attorney

Legally binding franchising paperwork is replete with critical information that you run the risk of overlooking if you do not have an expert franchise attorney on your side.

Before you put your signature on the dotted line, a franchise attorney will go through the Franchise Disclosure Document (FDD) and the Franchise Agreement with you. By working with a lawyer, you can ensure that you fully understand the requirements and obligations that come along with agreeing to start the franchise. That way, there aren’t any surprises down the road in the terms that might catch you off guard.

Businesses Accountant

It is important for every owner of a company to employ a reliable accountant who can give advice on how to set up your books and records, how to prepare for taxes, how to determine how much working capital is required, and a great deal more.

Expenses incurred throughout the building and construction process may include real estate fees, zoning fees, contractor fees, construction fees, and furnishing expenses, among others. 

A significant number of franchise companies will collaborate with the franchisee to choose the most suitable site for the new franchise. If renting is more your style, there is always the possibility of finding a place that you can rent.

Working with a business accountant will enable you to get started on the right foot by setting up your finances properly, learning what sort of figures and metrics you need to watch, and figuring out how to set up your business in a tax-advantageous way. It’s not easy to do all these things on your own, so having qualified help can make a huge difference in the long run.

Costs of Equipment

The costs of equipment will vary greatly depending on the business model and the type of franchise that you choose to invest in. For example, in order to own a Kona Ice franchise, you will need to invest in a Kona Entertainment Vehicle (K.E.V). 

If you are opening a fast-food restaurant like Popeyes or Kentucky Fried Chicken, you will need commercial fryers, ovens, and more in order to get your operation off the ground. This equipment typically doesn’t come cheap, so you will have to figure out the best financing options. Many national franchises will help you obtain and/or structure your financing, so you will definitely want to consult your national franchise rep about what your options are. 

It’s possible that if you are starting an office-based business, you may need to invest in printers, desks, and other office supplies, but opening a restaurant would require a far more expensive kitchen and serving utensils. Because of this, some companies, like Subway, provide the opportunity to lease their equipment.

Material Costs

If you’re going to create a storefront, you’ll almost certainly have to buy the products that you’ll be selling in order to get started. There are several different brands that provide recognized suppliers and have contracts in place for bulk buying.

There are extra expenditures that you may need to consider depending on the amount of money that you spend in the franchise, in addition to the prices and fees that have been discussed above. 

Each franchise’s FDD will go through all of the charges and fees associated with owning and operating the franchise, both in the short term and the long term. Although initial expenses and fees may give you the impression that establishing a franchise business will be prohibitively expensive, remember to keep in mind that these are all expenses that must be paid in order to launch an individual business of your own (with the exception of the franchise fee and the ongoing royalties associated with being part of a national franchise).

The distinction between a franchise and a non-franchise business lies in the fact that when you invest in a franchise, you have access to the complete support and direction of both the franchisor and the community of franchisees, in addition to the name recognition of an already successful company. On the other hand, when you start your own business, you will have to start from scratch without preset operational procedures and instructions, a national brand, tested and proven products, etc.

This is why franchises take ongoing royalty fees that are often calculated as a percentage of your total gross income. Depending on the franchise agreement, they may get paid on a weekly or monthly basis. Royalty costs are typically between 4% and 12% of a company’s total income. However, some businesses impose a flat monthly royalty fee instead. This is what makes franchising profitable for the national company.

Fees for Advertising and Marketing 

A well-known brand is one of the most appealing aspects of owning a franchise business. Because franchise firms invest a significant amount of time and money in promoting their brand to prospective clients, this should, of course, be beneficial to you as the franchisee. 

You will often be required to pay monthly marketing and advertising expenses, which are typically calculated as a proportion of your total income, in return for this marketing help. The typical range for marketing expenses is between 2% and 5% of the total income.

One of the benefits of a franchise is that much of the marketing is done by a professional national marketing team that is run by the national company. This takes a lot of the weight off your shoulders in terms of developing and advertising new products, building a brand reputation, and more. However, you will still need to do local advertising and other local marketing on your own to help drive business at your specific franchise location.

Other Fees

It’s becoming more usual for franchise organizations to demand monthly costs for things like technology, software, insurance, and further training, among other things. These fees may range anywhere from $100 to $1,000 each month. 

Item 6 of the Franchise Disclosure Document (FDD) will provide a complete and full listing of any extra fees that the franchise firm may charge for its services.

When discussing franchising, there are a great number of common words that must be understood. Be aware, too, that the price structure for each franchise is determined independently and that this information will be included in item 5 of the franchise disclosure document (FDD). 

Any franchise’s initial investment expenses will be broken out in item 7 of the franchise disclosure document. Be sure to read the terms and conditions carefully.

Is it More Costly to Start a Franchise Than a Business?

The answer is yes! If you want to own a franchise, you will need to pay a franchise fee and continuous royalties on the money you bring in. However, no such costs are associated with a small business. This is the main reason that starting and running a franchise is more costly. Additionally, these royalties never go away, so you will always be paying a percentage of your gross monthly sales to the national franchisor.

When purchasing the rights to create a location, it is not unusual to be required to pay a franchise fee of $40,000 in addition to paying a 6% royalty charge on the income the location earns. This is a regular practice.

This indicates that if your franchise generates $1 million in annual income, the franchisor will get $60,000 of that amount during the course of the year. Here are six primary benefits of purchasing a franchise rather than creating your own company:

Clear Operational Procedures

The franchisor will provide you with a playbook that covers everything from site selection to build-out to marketing to recruiting. You are relieved of the responsibility of determining these particulars on your own. Plus, you know that the playbook works, as it has typically been used by hundreds of other franchises successfully before. This means that you can go into running your business with confidence and a support system that knows what it takes to make your franchise a success.

Indeed, when compared to someone who is beginning a company from scratch, the typical individual who makes a purchase of a franchise today will likely have a far easier time opening for business. They won’t have to design their own operational procedures, products, or anything like that. Instead, they will be able to start running with a clear game plan from day one.

Risk Mitigation

If this is your first time launching a company, there is a good chance that you may make some rookie errors. When mistakes occur, both time and money are wasted. Because the franchisor has previously made errors themselves and altered the playbook to account for them, purchasing a solid franchise may help you avoid making many of them. They will be able to point you in the right direction and keep you from going down the wrong path in many instances (though not necessarily all the time).

In addition, there is probably some proof of concept for the franchise brand you are interested in, thanks to other franchisees who have previously launched shops in their respective markets. This is a major advantage that demonstrates a greater possibility of success (though it does not guarantee success 100% of the time).

As a result, opening a franchise is seen as much less risky than opening a new brand business. Lenders also see franchises as being less risky than new concept businesses and are therefore more willing to lend to them and often offer better interest rates. This can be a huge help for small business owners in the franchise industry.

No Experience Required

The most successful franchises have their marketing and operational procedures fine-tuned, which enables them to transform individuals from a wide variety of backgrounds into successful operators.

If you have spent the last 20 years working in corporate America, but it has always been your ambition to own your own restaurant, the best way to increase your chances of being successful in the competitive restaurant market is to purchase a franchise.

With franchises, you often don’t have to have any experience in the industry you are entering because of the training and operational guidance that the national franchisor will provide you with. This makes franchises much more accessible for individuals interested in becoming small business owners, especially if they don’t think they have what it takes to start a brand new business from the ground up.

Efficiencies within the Supply Chain

There are a lot of different franchises out there, and many of them provide cost reductions on the inputs your company uses. The franchisor is in a better position to negotiate cheaper pricing on supplies for the whole system now that there are hundreds of sites operational.

This indicates that you should be able to get the items you need at a price that is far lower than what you would have paid if you had established your own independent firm. This can help your franchise boost margins and make a larger profit in the end, thereby driving up your own earnings.

Strength in Numbers

Your locations are sure to profit from the increased brand recognition and marketing that will occur as a direct result of the expansion of the franchise that you are a part of, which may take place on a local, national, or even worldwide scale.

With a national brand, individuals will already be accustomed to your products and offerings, even when they are from out of town. In essence, it means you won’t have to do as much local reputation building and outreach because people will already know what to expect from your business (that said, you will still have to put some effort into local marketing and community relationship building).

Higher Exit Multiples Correspond to Brand Equity

Because there is power in numbers, franchising may result in the creation of some tremendously powerful brand names. Private equity businesses are always searching for reliable returns from their investments; therefore, this is of the utmost importance to them.

If all other factors remain the same, a private equity company will pay a higher price for 12 Dunkin’ Donuts outlets than they would for 12 sites of another kind of coffee business.

Why? Dunkin is a global brand that has a sizable client base and a marketing budget that is in the seven- to eight-figure range. Investing in a smaller coffee chain that competes with that has the opportunity for a greater upside and a far higher chance of a loss.

If you are selling your franchise to a single individual, it will also fetch a higher price typically than if you were selling a standalone business, for similar reasons to those previously stated. This makes franchises an appealing option for those who would like to have the ability to exit their franchise in the future.

Take Aways

If you decide to go alone as a business owner, it does not necessarily imply that you will not be successful. Nevertheless, it does indicate that you may have a more difficult time achieving your goals.

You will not only be responsible for figuring out everything on your own, but you also won’t have much purchasing power as the single owner of the business, and you won’t have any proof of concept for your particular brand. 

In addition to this, it is quite possible that you will be competing with other local franchise owners in your industry, some of whom may have the support of a big franchisor.

If, on the other hand, you choose to invest in a reputable franchise, there are a multitude of advantages throughout the whole process that can often justify the costs involved. Of course, there are also fees and added costs – as well as sometimes a more limited potential for growth – that come with starting a franchise business as opposed to a new brand. So, there are tradeoffs to be considered.

As with any business as well, you will need to give careful consideration to the early startup costs. However, you should also assess the regular fees and expenditures. It is vital to conduct your homework, read a firm’s FDD carefully, and get in touch with the organization if you have any issues. 

All-in-all, with the right mindset and the proper research, opening a franchise could be the right move for you. If you are passionate about starting your own business, want to get involved in a specific industry soon, and are willing to put in the hours and work, franchising is a great way to enter the small business industry.

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