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Working capital is an essential asset of any business. Prospective franchisees must remember to factor working capital into their cost calculations when joining a franchise. Prospective franchisees can often forget the need for working capital among the franchisor’s fees and ongoing royalties. But, having such capital available can make the difference between short-term failure and long-term profitability. This article will explain the costs of joining a franchise and how much working capital a prospective franchisee should have.
The Types of Costs Involved in Joining a Franchise
Typically, franchisors require franchisees to pay:
- an initial franchise fee;
- ongoing royalties; and
- ongoing payments towards the franchisor’s marketing fund.
The franchisees invest in the franchised brand by paying the initial franchise fee. This fee covers set-up costs and purchases the franchisee’s rights to operate under the franchisor’s brand.
Every franchise opportunity carries different financial obligations. For example, initial franchise fees can vary substantially depending on the type of business you will be setting up and the brand it will operate within. For instance, if your franchise is a mobile business, the initial fee will likely be less than that if you set up a new brick-and-mortar location.
Discover the key legal and commercial issues to consider when buying a franchise.
If you are considering joining a franchise, you should carefully read the franchise agreement and consider its terms. The franchisor will stipulate payment terms and a fee structure in this contract.
Prospective franchisees must also consider how they will cover additional costs in addition to the initial and ongoing fees. Such costs include the working capital to enable them to get their franchise location off the ground and cover any unexpected costs.
What is Working Capital?
Working capital is cash business owners have available to keep their businesses going. It is the difference between their assets and liabilities. A good amount of working capital indicates that a business can stay afloat for at least a short time.
Your franchise business will not be profitable immediately. For this reason, working capital is a crucial factor in your budget. You will not use it to pay the initial fee. Instead, you will use it to maintain your business, paying expenses and covering costs while it becomes profitable. As a prospective franchisee, working capital should be a pot of additional funds that you put aside.
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How Much Working Capital Should You Have?
There is no set amount of working capital that each prospective franchisee requires to ensure their new journey begins in a financially healthy way. Financial obligations vary across businesses and industries, and how much you need depends on the type of franchise business you intend to run.
Speak to the franchisor and their existing franchisees to establish how much working capital you need to get your business going. Review financial forecasts and create your own, making a detailed business plan. Some franchisors require prospective franchisees to have a certain amount, such as six months of working capital available.
When calculating how much working capital you need, consider costs such as:
- rent;
- utility bills;
- recruitment costs;
- employee’s wages;
- marketing costs; and
- inventory and equipment.
Where to Seek Capital to Fund a Franchise Opportunity
There are many ways entrepreneurs can fund a franchise opportunity, including the following:
- personal savings;
- support from family and friends;
- bank loans or loans from other lenders; and
- grants.
When seeking funding, ensure you know exactly how much capital you will need to develop your new franchise into a profitable business.
Key Takeaways
When joining a franchise, you must consider many aspects, including the costs you will incur. The franchisor will stipulate the fee structure in the franchise agreement. Read this and ensure you understand its financial implications. You will pay an initial fee and then ongoing royalties and marketing payments for the duration of the agreement. In addition to these costs, you must consider how you will keep your business afloat until it can make a profit; this is where your working capital comes into play.
There is no set amount of working capital that franchisees must have. However, some franchisors will stipulate that their franchisees have a particular amount to get them started. How much you need depends on the type of business you will run, the industry it operates in and the costs you will need to cover.
To establish how much working capital you need, read financial statements and forecasts and speak to the franchisor and their existing franchisees. Create a detailed business plan and ensure you have enough to transform your business from an advertised franchise opportunity to a profitable enterprise.
If you are a prospective franchisee who would like legal advice about joining a franchise or financing a franchise opportunity, LegalVision’s experienced franchise lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
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