Are you ready to buy a franchise? The answer depends on several factors. You need to be ready from a knowledge standpoint: aware of your own strengths and weaknesses, and clear about what you want to accomplish with your business and why. You also need to be ready from a mental standpoint: prepared to make the leap from employee to entrepreneur, and equipped for the work involved in setting up and sustaining a business.
Perhaps most importantly, however, you need to be financially ready. You need to know your financial goals and horizon, have a way to pay your bills until your franchise is profitable, and have sufficient assets for the purchase.
This last requirement is opaque to a lot of people. Franchise research turns up all kinds of financial terms, both related to the franchise purchase and to the franchisor itself. What do they all mean? And, at the end of the day, how much money do you really need in order to pass muster with a franchisor?
Based on my experience as a franchise owner and a franchise consultant, here are four key financial elements to consider when you’re trying to determine whether you’re ready to buy a franchise.
Liquid Capital
Every franchisor will want to know how much liquid capital you have on hand. Liquid capital consists of cash and cash equivalents, i.e., any asset you can quickly convert into cash without seriously hurting its value. This includes money market funds, stocks, bonds, CDs, and the like.
When you’re talking about buying a franchise, your liquid capital is the best tool for paying your franchise fee. The amount required will vary depending on the type of franchise you purchase. For instance, national-brand franchisors tend to charge bigger up-front fees than regional brands. And, of course, a multi-unit contract costs more than a single-unit contract.
Total Investment
Startup costs for a franchise don’t just include the franchise fee. Especially if you buy a brick-and-mortar franchise, you’ll have costs associated with setting up your storefront, purchasing equipment, stocking your supplies, and possibly hiring employees.
Very few people have enough liquid capital to cover a franchise fee and all their startup costs. New franchisees often finance some of these costs, typically through one of several lower-cost funding mechanisms that are available to small business owners. One option is a Small Business Administration-backed loan. Another is the ROBS program, which enables you to leverage your retirement savings to start a business (this is actually the option I used).
Working and Growth Capital
The biggest mistake I see with new franchisees? Undercapitalization. Some candidates think they just need to come up with startup costs, and then they can rely on business revenue once they open their doors. Like any business, however, franchises have a ramp-up period – usually 1-2 years for a single unit to become profitable.
That’s why you need working capital if you want to be ready to buy a franchise. Your business will generate some revenue at the start, so you just need a fund to cover your shortfall or any unexpected issues, like equipment repairs. I recommend stockpiling around 3x your monthly expenses for this purpose.
If you also want your business to grow (and who doesn’t?), you should additionally plan for growth capital. You can set this aside before you launch, so that you can start investing in growth right away. Or you can wait until your franchise is profitable and reinvest a portion of those profits back into the business. Either way, take some time to think about what kind of growth you want, and on what timeline, and make an appropriate financial plan.
Net Worth Requirements
If you grew up with the idea that it’s not polite to talk about money, you’re going to have to get over that notion before you apply for a franchise. Franchisors vet candidates thoroughly and will expect to see detailed proof that you have sufficient liquid capital, startup funds, and working capital to launch and sustain your new business.
They will also want to know your net worth. Why? Because your overall financial health is crucial to the staying power of your business. You won’t be able to pay yourself a salary until your franchise is on a solid footing. How are you going to pay your personal bills in the meantime? And if your franchise runs out of money earlier than expected, do you have more assets you can leverage to keep it going? If you don’t have resources to cover those situations, you’re more likely to throw in the towel.
Real Numbers
So, let’s talk real numbers. First, keep in mind that financial requirements vary across the franchise industry. There are very affordable franchises and very expensive ones. That being said, here are some averages you can keep in mind:
- Service-based (i.e., home-based) franchises usually require $75K+ in liquid capital, with a total investment of $100K+ per unit
- Facility-based (i.e., brick-and-mortar) franchises usually require $100K+ liquid capital, with a total investment of $200K+ per unit
These numbers may be higher if the franchise is:
- In a high-cost field (e.g., fast-food restaurants)
- Part of a national or very well-known regional brand
- In a geographic area with high real estate or construction costs (for facility-based businesses)
- In a highly regulated field, such as healthcare or childcare
To determine the working capital you’ll need, pay close attention during franchise due diligence. The franchisor should provide you with disclosure forms that indicate typical monthly expenses and time to profitability.
Where net worth is concerned, expectations can vary as much as the franchise costs themselves. But most franchisors want to see a net worth of at least several hundred thousand dollars.
A Word About Partnerships
Some candidates use partnerships as a way to pool resources and afford larger buy-ins, either for a big multi-unit contract or for a very expensive single franchise. Partnerships are not inherently good or bad – they’re just a neutral tool that can be used well or poorly.
If you want to set up a partnership, a written contract is crucial. Get advice from a lawyer who has relevant experience, and include guidelines for what to do if the partnership fails. And always have a personal exit strategy.
So, Are You Ready to Buy a Franchise?
Now that you know the financial requirements for buying, are you ready to make the leap? If so, book a call with me today. I can help you pin down the best path forward and identify franchise options that fit your financial resources and timeline. Best of all, my services won’t add to your costs – they’re always free!
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