8 Questions to Ask Yourself Before Opening a Franchise
As servicemembers transition out of the military, it is becoming more and more common to see them look to the franchise industry for their civilian career. This is because when it comes to owning and running your own business, it just makes sense to buy into an opportunity that gives you a solid foundation to build upon. Franchising offers a proven business model, complete with training, operational guidelines, and other means of support. Combine those attractive features with plenty of companies who offer special discounts to veterans, as well as lots of financing opportunities geared specifically towards veterans, and it starts to feel like business success is within reach.
The two key words above are “buy into.” Starting a franchise requires a major financial commitment. When you take the plunge, you could be making the single largest purchase of your life. While that may sound dramatic, it is important to understand what to expect when opening your own franchise. And even though it can be exhilarating and exciting to sift through the hundreds of excellent franchise opportunities available today, the most important thing you can do is take the time to ask yourself the following eight key financial questions to make an informed decision:
1. What is the total investment involved?
When looking into information on the investment required, you will inevitably receive a wide range of estimates from the franchising company. This is due to a number of factors, which depend on your own unique situation. Real estate creates the largest disparity between franchise concepts. Non-brick-and-mortar concepts obviously are much lower investment levels.
But even within the brick-and-mortar realm, you can have tremendous range in investment levels -- obviously a physical location in Honolulu or Beverly Hills will cost much more than Lima, Ohio.
Also, the amount of inventory you need to stock can affect your bottom line. Obviously, service-based businesses typically do not have a supply chain and thus costs are lower.
In cases like this, it is easier to just go for the lowest possible price, right? Not necessarily. One of the most important things you can do is take the time to find and talk to other franchisees in comparable markets to see how it went for them. This is one situation where you want to estimate up so you are not blindsided by figures higher than you expected.
2. How long will it take to reach the break-even point?
Your personal and business financial security depend upon a realistic (conservative) estimate of how long it will take your new business to reach its break-even point and start turning a profit. Although this is hard to pinpoint concretely, you should be able to come up with a realistic range, with the caveat that it almost always takes longer than most people think it will take. The best way to come up with a semi-concrete time-frame is by speaking to current franchise owners in comparable markets who are at liberty to share their financial information and historical data.
3. How much do I need in cash reserves to cover early losses?
The reality is that no one turns a profit on opening day. It might be months before your new business reaches its break-even point, which means you need plenty of operational cash reserves to see you through all those early losses. Do your homework to estimate the cash you need to cover expenses while you build revenue – and once again, aim high for expenses and low for revenue. It is better to guess modestly and come through slightly ahead that to plan on immediate profit and fall short.
4. How will I cover living expenses during the start-up phase?
Many new franchisees fail to consider that they will need a reserve for their living expenses before their business becomes profitable. The first step is to come up with a realistic figure of what you spend each month. Next, estimate how many months you need to cover until your business is successful enough to cover it. Then, add about three months onto that number.
While it may seem like it is going to take forever to reach your break-even point, just remember, it will happen. And in the meantime, knowing you have enough cash on hand will greatly reduce your stress and anxiety.
5. How much of my total investment needs to be in cash?
This will vary by franchise, but generally, one-third of the investment must come from the investor – this is called the cash injection. If it is a business where the investor (prospective franchisee) owns the commercial real estate on which that the business will sit, then the investor might only need to come up with 15-20 percent of the total investment.
The total investment includes both hard costs (equipment, inventory, furniture, fixtures, supplies, etc., if applicable) and the soft costs (franchise fee and working capital).
The low to high range of one's total investment would be clearly spelled out in the prospectus called the Franchise Disclosure Document (FDD). It is a very clear and easy-to-read document that is required by the Federal Trade Commission.
In addition, do not forget to include those cash reserves I mentioned earlier.
6. What are my financing options?
Most of us do not have piles of cash on hand, so buying your dream franchise is going to involve financing. Usually, this ends up being a loan, which means a lender is going to want to see your loan secured with collateral. That might be the equity in your home, a Small Business Administration (SBA) guarantee program, or both, in many cases.
A home equity line of credit often ends up being the best choice for many, but don’t forget to explore all the options available only to veterans. Other financing options include family and friends willing to support you, as well as organizations that help you gain penalty-free access to the money in your IRA and 401(k) accounts to start your business.
7. How much money will I be able to make?
There are ways to figure this out, with the caveat that in most cases, year one is a loss, year two is decent, and year three is often the first year you start making good money. The potential profitability of any franchise can be calculated using a wide variety of metrics, but there are three that are especially important to examine: average operating income (earnings before interest, taxes, depreciation, and amortization, also called EBITDA), average revenues, and the average sales-to-investment ratio. But in addition to these company-wide averages, I would still recommend talking to at least 10 franchisees to find out about their specific experiences.
8. Is the franchisor financially strong?
The financial health of your franchise’s parent company can have a significant impact on your success as a franchisee. You can easily get the audited financial statements for the franchisor, and if you are not confident in your ability to read, understand, and interpret the financials, find someone who can help you make sense of it. You want to see evidence the company is not just surviving, but is strong enough to offer the support franchisees need to be successful.
Opening a franchise is no small undertaking, and neither is preparing to do so. However, the time and effort you put into it will pay off by giving you a realistic picture of what to expect financially as you make your dream of owning and running your own business a reality.
David E. Omholt is a franchise advisor with Veteran Franchise Centers (VFC) – a RecruitMilitary strategic partner. His company offers a free service to veterans looking to learn more about the franchise buying process and options in the market. Omholt is a Certified Franchise Executive (CFE) and a frequent speaker on the subject of franchising on talk shows, at industry conferences, and on college campuses. He has been both a franchise licensor and a franchise licensee. Omholt is available at 866-246-2884 or firstname.lastname@example.org.