Every new business, be it franchise or independent venture, has startup costs. The advantage to franchises, however, is that the parent company generally provides an estimate of the initial required investment. Yet, as vital as this information may be, it’s often based on averages across the entire franchise. Employers usually must do some investigative work of their own to determine the true cost of ownership.
How do you determine franchise startup costs?
Franchise startup costs vary widely based on the franchise brand, industry and location. That’s why the best way to estimate expenses is to seek financial information directly from the franchisor or other franchisees.
Ask for a franchise disclosure document (FDD)
Franchisors generally are required to provide an FDD to prospective franchisees within 14 calendar days prior to any signed agreement. Item 7 of this document estimates the funds needed for the initial purchase and the working capital thereafter. It also typically outlines the payment method, due date and refund status for each expense.
Talk to other franchisees
Franchisees who recently opened a franchise may be willing to discuss their real-time operating expenses. Potential investors can then compare that information with estimates from the franchisor to get a clearer picture of the capital necessary to succeed in a particular market.
How are franchise fees determined?
When franchisors set their franchise fee, which is essentially a licensing fee, they typically choose a price that is both attractive to prospective franchisees and comparable to competitors in their market. The fee also may depend on how much the franchisor expects it will need to cover the cost of salespeople and any initial resources provided to new franchises.
Are franchise fees negotiable?
Although franchise fees are generally non-negotiable, franchisors sometimes offer incentives to entice franchisees who might otherwise be turned away by a cost of entry. They may defer the franchise fee to a later date or extend discounts to minorities, women and veterans. Limited-time promotions are also common if a franchisor is trying to establish business in a new geographic area or market.
Typical franchise startup costs
In addition to the franchise fee, franchisees can expect to pay startup costs related to the following:
- Real estate and property improvements
Location expenses typically consist of down payments on mortgages, commissions paid to real estate agents and security deposits for utilities. If improvements to the property are needed, additional costs, such as materials and labor, may be incurred.
- Professional services
New construction may require the assistance of architects and engineers, as well as lawyers to help with zoning permits and other legal concerns.
- Supplies and equipment
Examples include product inventory, point of sale devices (POS), general office supplies, cleaning products, smallwares, etc. Keep in mind that service-oriented franchises run out of a home or office usually need less supplies than those that sell goods.
- Furniture and fixtures
In some cases, franchisors will ask that all their franchises use the same type of furniture. In others, the franchisee may be able to use their existing furniture.
Like other businesses with employees, franchises need to purchase workers’ compensation insurance. Those that have a physical location also require property and casualty insurance, while mobile-based businesses must carry auto insurance.
Employee training may be covered under the franchise fee, but related expenses, such as travel, lodging and meals are usually paid separately.
- Advertising and marketing
Although individual franchises are generally responsible for their own signage, advertising expenses may be shared across multiple franchises.
- Working capital
Franchises may not turn a profit right away, so franchisees should have enough money upfront to cover their operating costs and living expenses for up to three months or longer.
How to finance the cost of starting a franchise
Starting a franchise generally requires more money than most people have on hand, but financing options are available. Franchisees that are able to secure a business loan typically follow these steps:
- Work with the franchisor
Franchisors may partner with lenders to create custom financing programs that cover the cost of franchise licensing, equipment, resources and other expenses.
- Apply for a commercial bank loan
Much like a mortgage, these types of loans have rates and terms that vary with personal credit history; a business plan may be required.
- Consult the Small Business Association (SBA)
Although the actual funds are provided by an intermediary lender, the SBA guarantees a portion of repayment, so interest rates and terms are usually more favorable than commercial loans.
- Seek an alternative lender
Investors outside the traditional banking system may be willing to fund a small business operation, but the interest rates are typically high and the repayment periods short.
- Consider crowdfunding
Prospective franchisees can create and promote their own crowdfunding web page or leverage existing third-party sites that crowdfund on behalf of specific business types and industries.
- Ask a friend or family member
Borrowing money from personal relations is a common way to fund a business, but it could cause conflicts if the terms of the loan aren’t agreed to by both parties in writing.
Frequently asked questions about franchise startup costs
How much does it cost to start your own franchise?
Franchise startup costs can be as low as $10,000 or as high as $5 million, with the majority falling somewhere between $100,000 and $300,000. The price all depends on the industry, location and type of franchise. Mobile and home-based businesses tend to be the cheapest, while full-service restaurants and hotels are some of the most expensive.
Can you open a franchise with no money?
Opening a franchise requires an initial investment. If franchisees don’t have the cash to cover the franchise licensing fee and other startup costs, they will have to apply for a loan with the franchisor, a bank or some other lender. So, at the very least, a good credit score may be necessary to open a franchise.
What is an FDD?
An FDD, or franchise disclosure document, provides prospective franchisees with information on what they can expect from a business relationship with the franchisor. It is considered an essential part of the franchise evaluation process and by law, must be provided to the franchisee at least 14 days prior to signing an agreement or exchanging money.
This guide is intended to be used as a starting point in analyzing franchise startup costs and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.