Top 10 Money Questions to Ask Before Buying a Franchise
Want to know how much money it'll take to buy a franchise, where to get the funds and how long it'll take to make a profit? Our expert provides answers.
There are many reasons people decide they want to acquire their own franchise business--and each of these reasons involves a variety of considerations. In the mind of most people contemplating such a decision, however, there is one overriding factor: money. If you're considering buying a franchise, you should be asking yourself a number of significant money-related questions. Here's what we consider the "Top 10":
1. How much total investment will this franchise require? This is a key question, since the Uniform Franchise Offering Circular (UFOC) document normally expresses this information in terms of a very large range of possible answers. In your calls to existing franchisees, and your research concerning your local market, make sure to narrow down these answers to provide as accurate an answer as possible. If you aren't completely sure, be sure to err on the high side.
2. How much will I need in operating capital reserves to cover losses after opening the franchise until it reaches the breakeven point in terms of cash flow? You're not going to have any customers or revenue on the morning of your first day in your new business, but you will have expenses. Until your revenue grows enough to cover these expenses, you're going to have to feed additional cash into the business to pay the bills. Make sufficient allowance for this factor in your plans and, when in doubt, guess high. No one has ever gotten into trouble on a new business startup because he or she had put too much in financial reserves.
3. How much extra cash do I need to cover living expenses while I'm starting my franchise? This is one of the critical areas many new franchisees fail to consider. After becoming a franchisee, there's a gap in time before your new business begins operation and typically another gap before it starts making enough profit to cover your living expenses. You need to carefully budget your living expenses to understand how much you'll need on a monthly basis and then make sure you've got sufficient cash--in addition to your business investment--to cover your expenses during this period. Then add a significant reserve on top of this amount--it'll help you sleep better at night.
4. How long will it take my new franchise to reach break even? This is one of the most important money-related questions you'll need to answer. It's no fun to feed extra money into a business to cover operating losses, but that's the reality in most startups. You'll normally find the answer to this question is a potential range of time for the franchise you're considering. Always plan that it'll take the longest time within this range to reach breakeven, so you're as safe as possible.
5. How much of my total investment (including capital reserves) do I need to have in cash? This answer can range from 0 to 100 percent, depending on the franchise business being contemplated. There's no right or wrong answer--just make sure you know what applies to you and that you easily have that amount of cash on hand.
6. What standard financing options exist for me? The most common forms of standard financing are bank loans and/or commercial leases. Any bank loan to start a new business will probably either have to be secured by your personal collateral (such as the equity in your home) or through an SBA guarantee program, and the banks may require both forms of security. Most new franchisees find that securing an open line of credit against their home equity is the easiest and least expensive form of bank financing available to them. Leases can also be a favorable option, since they are typically fast to procure and secured by the assets that are being leased (though they sometimes require a personal guarantee as well).
7. What alternative financing options exist for me? In addition to standard sources, there's always the standby financing source: family and friends. There are also a number of companies that assist people in accessing retirement dollars in IRA or 401(k) accounts, without early withdrawal penalties, to use as a funding source for a franchise business.
8. How much money can I make in this franchise? This is the $64 question. You will normally find the answer is related to the amount of time the business has been open. The first year will probably be a loss, but by the third year the business should be making good money. Ask a lot of existing franchisees about their experience at these levels, and make sure you know what your probable income will be by the time you complete that critical third year.
9. What are the ranges in financial performance of the existing franchisees? Though we've previously referred to the fact that there is going to be a range in franchisees' answers, this point is so important, it bears repeating. Don't stop your research until you are completely confident you know both the high and low end of the range. Two answers are not sufficient to establish a range you can have confidence in--10 or even more would be much better.
10. How financially strong is the franchise company? The franchise company is required to provide you with a copy of their audited financial statements in the UFOC document. You obviously want to work with a franchise company that is not only strong enough to survive, but that also has the resources to reinvest in training and support of the franchisees. Make sure you review their financials and ask for help from a competent advisor if you're not comfortable doing this yourself.
You should know the answer to each of these questions before you decide to invest in any franchise opportunity. If you do, and assuming the answers are acceptable to you, you can minimize some of your concerns about money as you build your new business.