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The Cost to Start a Franchise and Financing Options

The Cost to Start a Franchise and Financing Options-1

How much does it cost to start a franchise?” is one of the most frequently asked questions by prospective franchisees. But the answer – as it rarely is – isn’t as easy as the question.

General Franchise Opening Costs 

Note: While these costs below are common, they may not apply to every franchise system. 

The Wall Street Journal suggests being prepared to pay around 20% of the initial investment from your own money. But how much will it be? Short answer: it varies. There are thousands of franchise opportunities out there, all with different execution requirements.

 

Some franchises require franchisees to have commercial property, some can be based from home. Some franchises need specialized equipment, others don’t. The area the franchise will be located will also have an effect on cost as well.

 

Check the Franchise Disclosure Document (FDD) of a specific franchise brand for details on its investment costs, and don’t be afraid to ask the franchisor any questions you might have.

 

The FDD is an invaluable resource to have as you put together your budget for franchise investment. You can request a FDD, which must conform to Federal Trade Commission (FTC) guidelines, from a franchisor at any time but you must receive one to review at least 2 weeks before signing any contracts with a franchisor.

 

Within the FDD, the initial investment for the franchise is covered in detail within Items 5 and 7. Regardless of the franchise, there are some common costs involved with the purchase of a franchise. The first of those costs is the franchise fee.

 

The franchise fee is basically a cover charge for entry into a franchise system. Think of it as the fee you pay the franchisor for doing the legwork developing the brand, and saving you from many (not all) of the pitfalls that come with starting a business from the ground up.

 

Other common opening fees for franchises include:

  • General office supplies and equipment
  • Industry-specific equipment
  • Leasehold improvements and construction, if real estate is needed
  • Signage and decor, if not a home-based franchise
  • Inventory (if needed)
  • Professional fees (e.g. legal, licensing, accounting, etc.)
  • Grand opening advertising/marketing
  • Insurance
  • Taxes

 

The charts below illustrate the diversity of franchise initial investments for a new franchise unit. The charts were compiled from the 2016 FDD of each franchise.

 

Estimated Initial Investment for Budget Blinds


Name of Fee


Low


High

Initial Franchise Fee

$19,950

$19,950

Combined Initial Territory Fee and Additional Territory Fee

$65,000

$120,000

Excess costs of training

$250

$500

Work Vehicle

$350

$32,000

 Computer

$0

$3,000

MasterCard/ VISA terminal

$30

$500

Telephone Equipment

$60

$120

Auto Insurance

$1,000

$2,000

Commercial General Liability Insurance

$500

$1,000

Contractor's License and Bond

$0

$1,500

Additional Tools and Supplies

$100

$1,500

Additional Funds - first three months

$12,000

$20,000

ESTIMATED TOTAL

$99,240

$202,070

 

Estimated Initial Investment for Cruise Planners


Name of Fee


Low


High

Initial Franchise Fee

$495

$10,495

Application and Processing Fee for Financing

$0

$200

Rent – 3 Months

$0

$3,000

Office Equipment, Furniture and Fixtures

$500

$2,500

Start-Up Marketing

$500

$1,500

Technology Services Fee – 3 Months

$0

$177

Professional Fees

$100

$500

Initial Training Fee

$0

$695

Initial Training Expenses

$0

$150

Licenses and Permits

$150

$650

Miscellaneous Opening Costs

$100

$500

Additional Funds – 3 Months

$250

$2,500

ESTIMATED TOTAL

$2,095

$22,867

 

Estimated Initial Investment for a Hilton Hotel (300 rooms)


Name of Fee


Low


High

Franchise Application Fee

$95,000

$95,000

Product Improvement Plan

$7,500

$7,500

Market Study

Varies

Phase 1 Environmental Assessment

$0

$10,000

Real Property

Varies

Construction/Leasehold Improvement

$40,000,000

$65,000,000

Designer and Engineering Fees

$500,000

$2,000,000

Furniture, Fixtures and Equipment

$8,000,000

$12,000,000

Inventory and Operating Equipment

$1,500,000

$3,000,000

Signs

$50,000

$150,000

Computer Hardware and Software

$100,000

$250,000

Guest Internet Access Program

$94,500

$154,500

Required Pre-Opening Training

$15,000

$30,000

ADA Consultant Fee

$2,500

$10,000

Construction or Renovation Extension Fee

$10,000

$10,000

Insurance

Varies

Organizational Expense

$50,000

$200,000

Permits and Licenses

$100,000

$500,000

Miscellaneous Pre-Opening and Project Management Expenses

$1,000,000

$3,000,000

Contingencies

$4,000,000

$6,500,000

Additional Funds (working capital for 3 months)

$400,000

$1,000,000

eforea Spa Initial Fee

$75,000

$75,000

Additional Funds for eforea Spa Implementation

$0

$3,125,875

ESTIMATED TOTAL (does not include real estate costs, market studies, insurance, interest, or the cost of improvements under a conversion, re-licensing or change of ownership license)

$59,999,500

$97,117,875

 

Finding Outside Funding

How prospective franchisees plan to finance their franchises

(Graph part of our Prospective Franchisee Survey results, which can be viewed here.)

Since most people can’t finance the full cost of a franchise on their own, a meeting with a financial institution like a bank or credit union will be in order for many prospective franchisees. Luckily, according to an editorial in the July 2016 edition of Franchising World magazine, lending conditions have become much more favorable in the last couple years.

 

Before meeting with potential lenders, it will be to your benefit to prepare your documents in advance. Not only will it help expedite the process, it will help you show the lender you can be trusted with the responsibilities of a franchise business. Lenders strive to take on as little risk as possible.

 

The first thing you need to prepare is a resume covering your personal background. Detail your educational and work history, along with your proof of residence. In addition, collect your personal (and business, if applicable) financial statements for at least the prior 12 months, including bank statements and credit statements. It’s also recommended you collate your tax returns for the prior three years.

 

When deciding whether to approve credit for an applicant, lenders often consider the following, which Wells Fargo refers to as the “5 Cs”:

 

  1. Capacity: what is your ratio of debt to income?
  2. Capital: what other than expected income, in terms of savings, investments, etc., do you have that can help repay the loan?
  3. Collateral: will the loan be secured or unsecured? If secured, what are you pledging ownership of that has value if you were to default on the loan?
  4. Conditions: how is the money going to be used?
  5. Credit history: what is your track record of making on-time payments?

 

A large part of your financial background preparation will be covered in your credit report. Credit reporting companies Equifax, Experian, and TransUnion each independently track purchasing and payment history, along with job and residency history. Your credit reports can be obtained through AnnualCreditReport.com, a government website that provides streamlined access to free annual credit reports. 

 

Sometimes the information on one person can vary from bureau to bureau. If you find inaccuracies in any of your credit reports, you can have it corrected by contacting the appropriate bureau(s) with the contact information given on their respective websites.

The Cost to Start a Franchise and Financing Options-1

 

Lenders commonly also use a credit score to evaluate your loan application in addition to your credit report. All three credit bureaus generate their own credit score based on the information within their respective systems. Credit scores are commonly called “FICO scores” because they are generated using program software from the Fair Isaac Corporation (FICO).

 

FICO scores range between 300 and 850, and give the lender an overall feel of your credit situation. The higher your FICO score, the better. Elements used to determine the score are:

 

  • Payment history: 35%
  • Amounts owed: 30%
  • Length of credit history: 15%
  • Credit mix: 10%
  • New credit: 10%

 

The weighted percentages given above are for the general population. The importance of factors can vary slightly from person to person depending on his or her unique situation. However, all FICO scores are based upon the information from your credit report, so it’s paramount to review your credit report regularly for accuracy.

 

The conditions factor of the 5 Cs discussed above is covered by another document you will need to prepare before applying for financing: a business plan. Typical parts of a business plan include:

 

  • An executive summary: an overview of the business plan and the goals you have for the business. Many have found it best to write this summary last, even though it’s presented first.
  • A company (in this case franchise) description: describe the franchise you want to open in detail.
  • Market analysis: tell about the business industry the franchise is a part of with special attention paid to how it will benefit your specific area. Outline your competitors and how you fit into the big picture.
  • Management structure: who are you as a business person? Give some background in this section. If franchise ownership is going to be a group effort, outline the organizational chart and who will play which role.
  • Description of product or service: what are you selling specifically?
  • Marketing & sales plan: how are you going to get people to know you exist? How are you going to get them to buy from you?
  • Financial projections: this section should include at least a cash flow statement detailing your needs now and into the future, and revenue projections for at minimum the first year of operation.
  • Funding request: lay out a comprehensive statement of how much money you will need from the lender, including best estimates on when it will be paid back.
  • Appendix: the appendix serves as the spot of items that don’t fit into any other section, but you feel is important to show lenders to give them a full picture of you and your goal. Items such as resumes, media clippings you might have, pictures of potential sites can be here.

financing2_2016US.jpg

The franchisor is a great resource in completing this step as much of the needed information can be found in the FDD. Some franchisors even disclose potential earnings figures based on historical results from franchisees in the system (Item 19). Plus, some franchisors provide a business plan outline for prospective franchisees to use.

 

For more, see our guide for creating a business plan for your franchise

 

SBA Loans

In searching for financing options for your franchise, you’ll probably come across franchises that state they are “SBA approved” or something to that effect.

 

Unfortunately, that phrase doesn’t mean that you will automatically receive funding from the Small Business Administration (SBA) if the franchisor approves you for its franchise system. In actuality, the SBA itself doesn’t loan money directly at all. The agency offers partial guarantees for the loans to the banks that participate in its programs. 

 

SBA approval refers to steps franchisors have taken to make the loan process as short as possible for their potential franchisees. During the loan application process, lenders have to vet the person they’re giving their money to, as well as the business system they want to run. In a franchise situation, that means vetting the franchisee and franchise system itself.

 

Franchises that have received SBA approval are declaring that they’ve gone through a formal process with the SBA, essentially pre-vetting itself for future loan applications. As a result, the SBA loan process is simplified, or streamlined, for the franchisee – not entirely avoided. The potential franchisee still has to prove that he or she is a good candidate for the loan.

 

It’s similar to TSA Pre-check at an airport. Travelers with TSA Pre-check still have to go through security, but since they’ve already registered with the appropriate authorities they don’t have to spend as much time going through the security line as everyday travelers.

 

SBA loans are a common form of outside financing for franchisees. Approximately 10% of all SBA loans are to franchisees, and they have a maximum of $2 million per loan. The most common SBA loan for franchisees is the General Small Business 7(a) loan. For more this loan program, visit its page on the SBA website.

 

Other Forms of Franchise Financing

Franchisor Financing: Check Item 10 of the FDD to see if the franchisor offers financing options to its franchisees, or works with affiliates to assist franchisees with funding. While still not a majority, more franchises are providing financing assistance to franchisees to combat the current tight lending environment. Examples below are accurate as of the 2016 FDD of each respective franchise:

 

How much does it cost to start a franchise?-1

 

  • Anytime Fitness: has arrangements with a number of third-party equipment lenders who provide financing to franchisees, if they meet qualifications. The franchisor also has two direct financing programs that offer financing to qualifying franchisees to help finance tenant improvements, one of which is for new franchisees, and one for existing franchisees who are renewing their franchise.
  • Krispy Kreme: offers equipment financing to qualified franchisees who purchase doughnut-making equipment from the franchisor.
  • MaidPro: may offer financing to qualified credit worthy prospective franchisees for the purchase of a Select Market for $5,000 of the Initial Franchise Fee and a line of credit of up to $20,000 that can be used towards future payments as the franchisor prescribes.
  • Signal 88 Security: offers franchisees financing for their “ordinary, reasonable, and necessary business expenses” once franchisees begin operating their Franchised Business. The franchisor may also, from time to time, and at franchisees’ request, assist them in obtaining financing from a third-party for all or part of their investment.

 

Also, under Item 10 you will find out if the franchisor will help guarantee a franchisee’s loan, or take on a measure of responsibility for the payment of part of the loan if the franchisee were to default (not be able to pay).

 

Family and Friends: There are two main ways prospective franchisees gain financing from family and/or friends. The first is having a family member or friend join in the franchise as a partner, sharing the financial and operational load of the business – and also the profits that come. The second is a family member or friend offers a loan, which the franchisee pays back.

 

Before accepting the money in either of these scenarios, create an agreement with all parties involved outlining the terms and conditions of the arrangement in writing. Strongly consider employing professional assistance from a lawyer in drafting the agreement so all parties are fairly protected.

 

Agreements with family members or friends shouldn’t differ in construction from agreements signed with “normal” business partners. The goal is to have clarity on expectations beforehand to lessen the potential of hurt feelings down the road.

 

Non-Traditional Channels: Nowadays, prospective franchisees can link up with lenders online. The most popular of these sites is Boefly. Boefly operates much like a dating website.

 

After creating an account, borrowers on Boefly create a loan request that is matched to “compatible lenders” from the system’s 5,000 lenders and banks. From there, the borrowers and potential lenders make contact with each other, eventually completing the loan process. Franchisees from Toppers Pizza, Great Clips, Subway, Pizza Hut, and more have utilized Boefly to fund their franchise ventures.

How much does it cost to start a franchise?-1

 

Another intermediary option to finding financing is FranFund, which positions itself as a “concierge” of the funding process. People who use the service are paired with a financial consultant that guides them through the funding process, including figuring out which option will work best for them.

 

Retirement Accounts: This method is risky, but some people have found success with it. Instead of withdrawing money early from your 401K or IRA, which would likely be subject to extra taxes, you can set up a C corporation to be the owner and operator of the business. Once the C corporation is set up, you can roll the money into the corporation’s profit sharing (or stock) program. Money within that program can them be invested into the franchise.

 

As mentioned before, financing a franchise with money pegged for retirement is risky. If the business doesn’t work out, you may significantly less money, if any, to fall back on. If considering this option, it is paramount to speak with an accountant to avoid penalties from the IRS. BeneTrends Financial is a company that specializes in helping prospective small business owners use retirement funds to fund their dreams.

 

Franchisee Financing Case Studies

The following are brief, real-world examples of how some franchisees used the aforementioned methods to acquire the necessary funding to reach their franchise ownership goal.

 

Franchisor Financing

With his good credit score and solid track record as a businessman Remi Tessier thought it would easy for him to acquire financing for a Marco’s Pizza franchise in Warner Robins, Georgia. However, that wasn’t the case.   

 

He disliked the terms and conditions he was presented with after going through the lending process with multiple banks, going as far to call them “outrageous.” As a result, he turned to his franchisor, Marco’s Pizza, for assistance. Through the company’s leasing program he eventually received $250,000 toward the initial cost of opening the pizza restaurant.

 

Financing from Family and Friends

When Sandip Patel moved to the United States he was “financially unstable [yet] did not want to work for any one.”  He had a desire to own a Dunkin’ Donuts franchise, but had to find a way to come up with the initial investment. He found a lender in his cousin, already a Dunkin’ Donuts franchisee, who loaned him $120,000 to get started. 

 

The arrangement included Sandip making monthly lump sum payments to his cousin for reimbursement.  In addition, his father loaned him an additional $150,000. With the support of his – and family hard work – Sandip’s franchise ambitions flourished. He eventually opened four Dunkin’ Donuts and four Taco Bell franchises.

 

Sandip’s recommendation to other prospective franchisees is to take careful consideration and planning before accepting a loan or entering partnership with family (or friends). “I had proper documentation and everything was in depth. I [still] have a solid standing relationship with my family.”

How much does it cost to start a franchise?-1

 

Non-Traditional Channels

Already founders of a packaging company, Les and Claudia Davis sought to further expand their business portfolio with a TCBY frozen yogurt franchise. 

 

From prior experience, this husband and wife duo understood the funding process and sought to make their latest venture as painless as possible. They consulted with their franchisor about financing, and TCBY recommended BoeFly. After creating their loan request on BoeFly’s website, they received several inquiries from interested lenders.  Following a close evaluation of offers from across the country, they chose a bank located near them in Richmond, Virginia.

 

“As entrepreneurs, Les and I have learned the great amount of efficiency and resourcefulness required in the start-up process, and we have applied this in our search for financing as we prepared to open our first frozen yogurt store,” Claudia says. “We found BoeFly to be an ideal solution that offered us a variety of funding options and connected us with a bank right in our area.”

 

Retirement Account

For Glenn Burrell, franchise ownership gave him the opportunity to retire from the financial-services industry in New Jersey and change careers. “I wanted to own my own business, and franchising was the best way for me,” he says. After several months of searching he landed in the technology industry as a franchisee of CMIT Solutions, an information technology consulting and computer support services franchise. 

 

After picking a franchise, Glenn researched ways to fund his venture, honing in on FranFund and BeneTrends. After careful consideration, he went with FranFund to assist him in using his 401(k) to fund the franchise. 

 

According to Glenn, using his retirement fund as the path to franchise ownership fit his situation because “instead of investing in other things, I saw an opportunity to invest in myself. I didn’t have to worry about loans, interest, or operating loans. My funding experience was a very easy and obvious choice—rather than other alternatives—because those funds were sitting in my 401(k) plan.” 

 

The process of financing his franchise with his retirement funds took Glenn around four-to-six weeks.  Glenn advises others seeking franchise funding “to make sure you do the due diligence. Research the business model thoroughly. If you can afford to overfund, especially with a 401K, do so.  It’s better than getting cut short.”

How much does it cost to start a franchise?-1

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Don’t forget there are also plenty of small business loans and grants out there. Start with this listing from the SBA, and don’t give up in your quest for financing your dream of franchise ownership.

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