When you’re buying a franchise unit, cost may be one of your biggest deciding factors. It’s what will determine how much money you need to buy a franchise. But what you may not know is that the asking price of a unit is only the beginning. Here are eight costs you’ll need to consider when evaluating and comparing franchise units:
Initial franchise fee.
Most franchisors charge tens of thousands to hundreds of thousands of dollars for the rights to set up a franchise unit. In exchange for this fee, they give unit owners the right to use the business’s name, its format or system, and its marketing collateral. They may also provide training, support, and assistance in finding a location or working through other challenges of startup and ongoing operations.
Many franchisors charge ongoing royalty payments based on a franchise unit’s weekly or monthly gross income. This fee is often 2-10 percent of total revenue.
In most cases, franchisees pay the royalty fees even when their net income is negative, the franchisor fails to provide promised services, or the franchise unit owner terminates the franchise agreement before the end of the franchise contract.
Franchise unit owners generally pay to promote their local franchise unit. However, some franchisors also require their unit owners to pay part of the organization’s national advertising costs, which may be used to attract new customers in other parts of the country and new franchise owners, too.
Real estate and related costs.
Franchise unit owners are responsible for purchasing land or buildings, making updates or modifications to existing buildings, or paying rent and security deposits to a commercial property owner for the use of their structure. Additionally, owners are responsible for paying local property taxes, utilities, licenses, and other costs required to run a business in a specific location.
Franchise unit owners typically pay for the outdoor signage for their business. Most franchisors require unit owners to purchase their signage package, which can be quite costly.
Franchise unit owners must cover the costs of essential equipment. While many franchisors specify the precise models of equipment their unit owners must attain, they may arrange deals with distributors to reduce the price new owners pay to purchase or lease that equipment.
Franchise unit owners should plan to cover the costs of their opening inventory needs. Many franchisors advise attaining a two-week supply of inventory, but others, especially those with complex sales models, may require a much greater supply.
Franchise unit owners should plan to have 12 months of working capital on hand to cover the costs of operations, especially since it can take a year or more for a franchise to become profitable.
Costs of operation may include rent payments, utility payments, cash-on-hand to make change for customers, salaries and wages, inventory needs, emergency repairs, and other recurring or one-time expenses.
These costs will vary by franchise and region of operation, but you can arrive at a reasonable estimate by speaking with a franchise representative and reviewing the franchise disclosure document (FDD).
What are the cash requirements for opening a franchise?
So how much money do you need to buy a franchise?
Many franchisors require prospective owners to have enough cash on hand to invest in the business, plus a baseline net worth (calculated as the total value of your assets minus your debts and liabilities).
In 2020, we pulled a sample review of some popular franchises owners like to invest in. We found these personal asset requirements using publicly available data:
Cash on-hand requirement
Personal net worth requirement
|Ace Handyman Service
|Allstate Insurance Agency
|Checkers Drive In Restaurants, Inc.
|Jackson Hewitt Tax Service
|Jimmy John’s Gourmet Sandwiches
|The Cleaning Authority
|The UPS Store
How can I cover the costs of a franchise?
Start by assessing how much cash you have on hand to invest. Review your savings accounts, investment accounts, vehicle values, insurance cash values, and home equity availability to calculate your personal asset resources.
Retirement accounts are an often-overlooked investment vehicle that can be used to cover many of the costs of a franchise startup, though, of course, there are some risks to using this pool of money. There are three ways to access your retirement account assets to help you with your purchase:
Option 1: Loan
You can access the money in your 401(k) with a 401(k) loan. In some circumstances, you may also be able to borrow against a 403(b) or a 457(b) account.
Option 2: ROBS
You can access the money in your 401(k), traditional IRA, SIMPLE IRA, SEP-IRA, 403(b), 457(b), Keogh plan, or thrift savings plan (TSP) by setting up a rollover as business startup (ROBS) scenario.
Option 3: Distribution
You can take a simple distribution from your retirement savings account.
You can learn more about these options in this guide:
Can I borrow money to cover some of the costs?
In most cases, yes. Given how much money you need to buy a franchise, loans are a popular choice.
Most lenders won’t loan you money to cover the upfront franchising fee. However, many give loans to cover the costs of real estate purchases, equipment, or ongoing cash needs. Here are some loan options you could consider:
|The Small Business Administration (SBA) offers two kinds of loans that help owners access the capital they need to start or build a business.
In this guide, we explain 7(a) loans and 504 loans and how you can use them to make your entrepreneurial goals a reality:
|Some franchisors have programs in place that help owners cover some or all the funds they need for their initial investment. In some instances, the franchisor acts as a lender. In others, the franchisor connects new owners with a partner lender.
You can learn about this form of financing in our guide, Considering Franchisor Financing? Here’s What You Should Know.
|Many bank lenders also offer term loans that allow owners to borrow a specified amount of money for a specific business purpose. These loans can be difficult to qualify for, but they are often a great option for qualified borrowers.
Learn more about term loans in our guide, An Overview of Term Loans for Franchisees.
Lines of credit
|Some lenders set franchise unit owners up with a line of credit to access cash when and how they need it. Lines of credit aren’t often used to fund large purchases, such as startup costs, but they can help unit owners cover early irregularities in cash flows.
Lenders don’t always advertise this form of financing, but many offer it to those who inquire. Contact your preferred lender to learn more about this option.
|Many commercial banks, community banks, and credit unions allow small business owners to access capital by borrowing against their assets. These might include inventory, machinery, non-mortgaged real estate, or other tangible assets with verifiable value.
You can learn more about these kinds of loans and their qualifications in our guide, Asset-Backed Financing for Franchise Owners.
When expensive equipment is involved, many franchisors put programs in place to help owners cover the costs. The franchisor might set up deals with equipment wholesalers or distributors to attain favorable prices. Sometimes, they ensure that the dealer will finance the equipment with a loan or lease with favorable terms.
Contact the franchise representative at your target franchise to learn about this option.
For most of these options, creditors will make lending decisions based on your credit score, income, net worth, debts, and experience running or managing a business. Some loans, including those that collateralize assets, put less of an emphasis on personal credit than they do on the value of what they can reclaim in the event of a default.
Another option you might consider is partnering to raise the capital you need. The benefit here, beyond access to their financial resources, is the managerial know-how or industry experience they can bring along to help your business. Learn more about partnering opportunities, benefits, and considerations in this guide:
Which option is right for me?
Before making any financing decisions, you should meet with a small business accountant to weigh your options. Your accountant can help you compare the rates, terms, and risks of every option you consider and plan for repayment.
Need help finding an accountant? Connect with these highly qualified accountants who excel at working with clients just like you.
Once you calculate what you can afford to spend on a franchise and how much you’re willing to leverage, you can move on to the next step of the process. That’s finding franchise opportunities that allow you to put your skills and experience to work.
We can help you with this important step and every other part of buying a franchise unit. Log into your owner’s portal for articles, checklists, and advice you can use to make your venture a success.