16 Dec Take These Three Financial Steps Before You Invest in a Franchise
Note from Tom West: The three steps in the following article are the same three steps every business broker should take prior to representing a franchise.
Before you write that check for a franchise investment, make sure you take these three key steps.
There is a comprehensive process involved in the purchase of a franchise. It involves a thorough evaluation of a franchise opportunity by obtaining feedback from current and former franchisees. However, although the practice of gaining franchisee feedback is important and franchisee candidates are routinely reminded to follow up in this area, there are three financial steps that need to be taken but are not always discussed.
If prospective franchisees take these steps, they will minimize their risk of failure and maximize the odds of protecting their investment. Ask franchise attorneys what the causes of franchisee failure are, and one of the reasons constantly cited is a lack of sufficient working capital.
Here are Three Steps that can Protect a Franchise Investment
1. Confirm that the initial investment in Item 7 of the Franchise Disclosure Document is accurate. Franchisors are allowed to present an estimated low and high amount in the Item 7 Table for the start-up investment in the franchise and have fairly wide latitude. Keep the word “Estimated” in mind and do some investigating on the costs of rents, equipment, supplies and other items in Item 7 by speaking to the franchisor and franchisees. Do your own review and pay particular attention to the last item, Additional Funds. Franchisors are allowed to provide an estimated 3 months of funds a franchisee will need for personal expenses. Once again these funds represent an estimate and only for 3 months.
2. Once you’ve verified the initial investment to the best of your ability the next step is to do a cash flow projection. A word of caution: If the franchisor doesn’t provide an Item 19 earnings disclosure then consider walking away. If you have difficulty doing a cash flow projection then use an accountant to assist. The importance and value of this step is to have a highly accurate amount of capital required to invest in the franchise.
3. Once you’re identified the capital investment needed for the franchise, be sure you have approximately 10% of that amount set aside or available for unforeseen events that may arise. When starting a new business whether it’s a franchise or independent operation there is a tendency for the founder or owner to under estimate the amount of capital that is needed. Moreover, there is a tendency to expect events to unfold as planned; however, life rarely works that way.
Before signing the franchise agreement and paying the fee be sure to take the three financial steps outlined above. This will help protect your investment and lower the risk of being capital starved.