Emma Lusty of Hamilton Pratt reveals the costs a prospective franchisee needs to be aware of
Once a prospective franchisee has decided in what business sector they want to start a franchise, they will then have to establish what franchise they can afford, either from available funds or with the assistance of a bank loan.
The cost of entry into a franchise network will include, for example, the initial fee payable to the franchisor, property costs, equipment costs and legal costs. Entry costs will vary greatly, depending on the type of franchise and sector, whether industrial or retail premises are required or the franchisee can operate from a home-based office, and what equipment and goods are necessary to commence trading.
The costs associated with starting a franchise tend to be front-loaded, with a large proportion of them being incurred before the franchisee starts bringing in any money, so available working capital will be very important for any fledgling franchisee.
Most franchisors will charge an initial fee, which is the fee payable to use the franchisor’s brand and system, as well as paying for the initial obligations the franchisor has to fulfil.
The amount will vary, depending on how well established the franchisor is and the amount of assistance the franchisor provides in the initial stages of a start-up. Some franchisors may charge a separate package fee in addition to the initial fee.
Preparing for the opening of the business may be as simple as acquiring a computer or van - either outright or via a leasing arrangement - or it might involve acquiring and fitting out commercial premises.
A franchisee may have to acquire an initial amount of stock and there’s likely to be expenditure on an initial launch and marketing campaign. However, the franchisor may include those items in the initial fee, so it’s important a franchisee establishes exactly what the franchisor will be providing for this sum of money.
In many cases, a franchisee may have staffing costs to consider. Such costs will have an impact on the franchisee’s working capital requirements because the franchise is unlikely to trade profitably during this period.
Some franchisors will require a franchisee to demonstrate they have a minimum personal investment level from the outset, in addition to any bank or alternative funding. This ensures a franchisee has sufficient cash to remain afloat in the beginning, but it also ensures a franchisee is motivated to make a success of their business because they have skin in the game.
Cash is king. A franchisee will need to ensure that, once their business starts to trade, they have sufficient working capital available to them to get them through what may be a tough few months as they build the brand and reputation in their territory and establish their business.
A franchisee will also be required to make monthly payments to the franchisor. These are usually based on a percentage of the franchisee’s turnover. However, some franchisors require a minimum payment each month, even if the turnover of the franchised business is low. This will need to be factored in when establishing the franchisee’s working capital requirements.
The fees will usually be broken down into the management service fee and the marketing fee. The management service fee will cover the franchisor’s costs associated with being a franchisor and providing support to its network of franchisees. The marketing fee should be used solely for marketing the franchised network.
In addition, a franchisee may have to agree to spend a minimum amount each year on marketing their business in their territory. Depending on the systems required by the franchisor, for example in networks where the franchisor has a sophisticated customer relationship management system, there may also be a software support fee payable.
In some cases, franchisors either do not charge an ongoing monthly fee or charge a lower than usual monthly fee, which is often because the franchisee is required to purchase goods from the franchisor.
It’s on the mark-up on those goods that the franchisor makes its money. In this case, a franchisee should ask the franchisor for details of mark-ups and any other preferential terms the franchisor gets the benefit of.
According to the British Franchise Association/NatWest franchise survey 2015, the average ongoing fee is 11.7 per cent of sales. In our experience, the management service fee will be in the region of eight per cent of gross turnover per month, while the marketing fee tends to be in the region of two per cent of gross turnover per month.
The mean total sum invested on a start-up, according to the bfa/NatWest franchise survey 2015, is £107,000. It’s worth noting there is a huge variation between mean start-up costs, which range from £136,000 for a hotel and catering franchise to £42,000 for a personal services franchise.
A prospective franchisee should gain as much information as possible from the franchisor about the average start-up and ongoing costs for franchisees in their network and use that information to prepare a thorough business plan, so they can ensure the business is viable for them.
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