The Hidden Costs Of Buying A Franchise

Posted: 15 May 2016
Estimated Read Time: in about 18 minutes

Working capital misconceptions, cash flow myths and potentially hidden extras. it’s not that franchisors are trying to fool you, Dan Archer, franchise director for Promedica24, says

The Hidden Costs Of Buying A Franchise

More often than not, things are clear and transparent. However, there are important questions that need to be asked before you make what is likely to be one of the biggest financial decisions of your life.

Before you sign on the dotted line, be sure to have looked closely into the financial implications of investing in a franchise. Here’s my advice on what to consider:

WORKING CAPITAL

The phrase is bandied around all too frequently in franchise marketing. An opportunity is £30,000 plus working capital. What most people don’t realise is that working capital can range from £5,000 to over £100,000, depending on the nature of the business and the industry in which it operates.

So what is it? Working capital is the money you will need over and above your initial franchise fee. It’s to cover business costs and your own personal earning requirements for any period of time that your business is not making a profit. Business costs can include premises, staff, stock and professional charges such as insurance or regulatory fees. For example, most healthcare franchises require large sums of working capital, typically £80,000- £100,000. This is because they require you to operate from an office and employ a care manager before you can legally take on your first client.

The reason Promedica24’s working capital requirement is so low at around £10,000 is because franchisees work from home and don’t need to employ staff, as this is managed by head office. This type of information is crucial to you in your financial decision making process.

Personal costs need to cover your own monthly financials. What do you need to run your home, support your family and honour your existing credit commitments? Be honest with yourself when disclosing your monthly earning requirements. There’s no point underestimating your outgoings in order to try to make your financial projections seem more attractive to a franchisor or bank if you’re applying for finance.

 

CASH FLOW

Cash flow isn’t just about money in and money out. It’s about timings and projections and is one of the most important business planning tools.

Not all franchisors issue trading projections that include cash flow. If you don’t receive them as part of your recruitment process, please ask for them. You may be required to sign a non-disclosure agreement before a franchisor will release this type of information to you, but this is standard practice and you shouldn’t be put off by it.

You should draw up two different cash flow projections based on best and worst case scenarios. The worst case scenario should look at what happens if your business performance is less than projected by the franchisor. This may result in more months of negative cash flow and, therefore, require more working capital investment.

Don’t assume your best case scenario figures mean plain sailing for your business either. Think about what will happen if your franchise performs at a higher level than projected by your franchisor. It will almost certainly mean you reach break-even sooner, but it could also mean there will be a shortfall of cash within the business due to overtrading.

What do I mean by overtrading? Let’s say you’re planning on selling £1,000 per month of stock. Your suppliers expect to be paid in advance and the people you sell to need credit. This means you need a cushion of cash to cover you for £1,000 per month. This is part of your working capital.

But if you sell £2,000 of stock in a month, you’re going to suddenly need twice as much working capital, even though you’ve been more successful than you originally planned. By exceeding projections you could also need more staff or larger premises.

The moral of the story is, don’t invest every last penny you have into the business. Things change and you need to be able to adapt. Planning in this way is one of the most effective ways to prepare yourself for running a successful business.

If for any reason, even after you request them, a franchisor does not provide trading projections that include cash flow, you need to work with someone who can help you draw up a set regardless. This could be an accountant, business coach or banking professional.

 

HIDDEN IN PLAIN SIGHT

The majority of franchisors will charge you a management service fee and/or marketing fund fees. These are not hidden costs, they’re vital to your success as a franchisee.

MSFs create an ongoing commercial relationship between franchisor and franchisee. Without them, a franchisor cannot be expected to maintain a vested interest in the success of each business owner in their network.
The question to ask isn’t: “Why am I paying this?” it’s: “What am I getting for my money?” What support, services or core products does your franchisor provide in return for your MSF?

MSF charges are structured differently from franchisor to franchisor. Some adopt a percentage of turnover, which means charges will seem minimal in the initial months, but increase in line with your turnover. Others work on a fixed fee basis, a flat rate that remains the same no matter what.

Some have separate MSFs and marketing funds, while others combine the two, so at a glance could seem more expensive. Take time to understand how this impacts you and your business going forwards.

 

INTEREST FOREGONE

When you invest in a franchise, regardless of the manner in which you are funding your purchase, there’s going to be a lump sum payment involved. Part of weighing up the pros and cons of buying a franchise is remembering things like the interest you will forgo on your investment.

Take a moment to calculate the interest your cash is likely to earn you if invested in a high interest savings account, bond or other type of financial investment. Factor this loss of income into your earning aspirations when setting goals and targets in your business plan.

 

FRANCHISE FULL CIRCLE

A key financial aspect many people neglect to consider at purchase stage is maximising return on investment upon exiting the franchise.

It’s important to understand the potential future value of your business. In the simplest of terms, the cost to your resale buyer needs to be more than you had to pay to start with - this includes franchise fee and any working capital. You will have invested time and effort to build the business, the brand and relationships in your territory and will accumulate a goodwill value as a result.

With this in mind, it’s often worth earning less in the initial year or so while you build your business on the understanding that the value in the business will be compound in years to come.

Franchising is proven to be a far less risky route to business ownership than going it alone. A good franchisor will be as clear as possible with you on all financial aspects of the business. It’s up to you to ensure you understand the information provided. If in doubt, ask more questions.

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