HOW MUCH IS A FRANCHISE?

An easy guide to purchasing costs.

Dave was feeling frustrated. Once again he was on the phone to his accountant who was helping him with loan documents. He had spent the last few weeks trying to arrange finance for the franchise he wanted to buy. Getting the money to buy a franchise was proving harder than he had anticipated.

Karla was also on the phone to her accountant. She had just opened her fitness studio. Money was tight even though they had good customer numbers. The build-out of the studio had cost a lot more than she anticipated and her credit card debt was growing by the day.

These situations are common in today’s franchise climate. So, if you’re thinking of buying a franchise, it’s a good idea to understand what it will cost to get up and running and what the financing options are. This will help you avoid the frustration of falling at the final hurdle and the stress of going over budget.

It can be a bit tricky to work out the cost of a franchise. That’s because there are several components to the price. However, once you know the main components, you should be able to gather the information you need.

THE KEY COSTS IN A FRANCHISE PURCHASE

There are five main categories of cost: 1. Franchise fees

2. Equipment

3. Fitout

4. Legal and accounting

5. Other costs, including uniforms, stock, and initial marketing costs

If you are buying an existing business, items 2 and 3 are included in the cost of the business you are buying.

1. FRANCHISE FEES

Franchise fees are usually quite easy to find out as they should be clearly stated in the disclosure document. The franchise fee can be described as the up-front fee for the right to operate the franchise.

Your initial payments to the franchisor may also include other components. The most common one is training fees to cover the cost of your initial training program. This might be additional to the franchise fee, or it may be included.

In some cases, the initial fee might include specific services and even equipment. For instance, in one franchise we know, the initial fees include computer equipment and setup.

2. EQUIPMENT

Most businesses require some type of equipment. This may be as straightforward as a phone and computer, or a van and tools. For a food business it might include fridges, freezers, cooking equipment and tables. If you’re buying a fitness business it will include the exercise equipment.

If you plan to operate from a home office you may need furniture such as a desk and chair, and storage space.

The costs for these items should be very clearly specified. Ideally the franchisor should be able to provide you with a list of every item you need and the costs of those items.

3. FITOUT

If your business will operate from a

physical location (shop, cafe, gym etc) you’ll need to pay for the premises to be fitted out. This may be a simple matter of some paint, or it can include complex planning applications, building works etc.

4. LEGAL AND ACCOUNTING

You will need to pay for your own costs of legal and accounting advice. Depending on how complex the agreement is, this cost can range from $3000 to $5000, or more. Extra costs come along when you need lease agreements, complex company structures etc.

Apart from your own costs, some franchisors require franchisees to pay the costs of drawing up the franchise agreement.

5. OTHER

Whenever a person buys a business there are various “other” costs.

Depending on the franchise you are buying they may include: initial advertising, licences and permits, stock for sale and sundry supplies, uniforms, a business phone, business cards, and so on.

A well-prepared franchisor should have defined all these costs, but it’s also a good idea to ask other new franchisees what their other costs were.

BUYING AN EXISTING BUSINESS

If you are purchasing an existing business there are also several types of costs.

First is the price that you negotiate with the vendor of the business. This will be made up of equipment that you purchase and, usually, an element of goodwill. Goodwill is the amount you pay over and above the value of the assets for what finance people call “future maintainable earnings”.

But the purchase price isn’t the only cost. There will also be franchise fees, training fees and the legal and accounting costs. You might also have to pay for refurbishment or new equipment.

THE COSTS THAT PEOPLE FORGET

So far we’ve talked about the costs that are relatively easy to define, but you’ll encounter other costs that may be less obvious. These are the amounts of money you will need to spend to fund the business during its start-up phase.

Most new franchisees discover that they need to put money into the business to pay expenses in the first few months. That’s because the initial income for a new business is usually not enough to cover all the expenses. In addition, the owner has living costs to cover.

This means that you will need an amount of money to cover these operating costs.

HOW TO WORK OUT THE COSTS

In order to work out the costs for the franchise you’re considering, you will need to look in a few different places and ask some questions.

The main source of information is the disclosure document. But the franchisor should be able to provide you with a written summary of the franchise costs when you make your initial inquiry. If they don’t do this, you should ask for one. After all, how

can you decide if the franchise is within your budget if you don’t know the costs!

Apart from the disclosure document, we recommend you ask recent franchisees what their costs were. This will help you validate the costs of setting up the franchise.

It’s a good idea to create your own table showing the various costs and your own notes about them, as above.

Once you know the costs, you can work out how you will finance them.

By taking a methodical approach to understanding the costs, writing them down and validating them with established franchisees you’ll be able to assess whether you can afford the franchise and reduce t he chance of

financial surprises down the track.

Kate Groom has a background in economics, accounting and franchise management and helps franchisees make better use of planning, communication and technology to improve business management.