Finance Questions to Ask Before Investing In a Franchise

08/04/2018 08:00 | Start a business

Finance questions you should ask when investing in a franchise

Before you invest in a franchise, it’s important to get as much financial information as possible so you can get a realistic idea of how much you could earn. This will help you evaluate the franchise opportunity and determine whether it will meet your long-term financial goals.

1 - What are the minimum and maximum investment required?

While all franchise brands should provide objective financial information on their websites or in their franchising brochures, it’s still a good idea to ask this question to make sure the franchisor doesn’t come up with a different figure than what they’ve published. If there is a discrepancy between the numbers advertised on the website versus what you hear in the interview, this should cause concern. It may suggest the franchisor is not being transparent or honest about the financial requirements or the earning potential of the opportunity.

3 – What is the royalty fee, and can this be changed?

Your franchisor will typically charge a monthly royalty, otherwise known as the ongoing management fee, in exchange for franchising its business concept and providing ongoing training, support and other services. Again, this should be stated on the franchisor's website or in the brochure, and you'll need to be aware of the fee structure.

The fee structure

A franchisor will generally charge a fee based on your sales, as the head office won't need to check your accounts to verify that you're paying the correct percentage. The issue with this arrangement is that it can be harder to make a profit if you have high expenses, as the franchisor will charge the same franchise fee regardless of what your net profit is.

Check how the franchisor’s royalty fee compares to other franchises in the same sector so you can determine whether this seems too high (or even too low!). Depending on the franchisor and your business plan, you may be able to negotiate a lower franchise fee or a different fee structure before you start the contract, or once you become profitable.

4 - What sort of funding is available?

Many franchisors will have good working relationships with banks that have expertise in lending to franchises. The larger and more established the franchisor, the easier it may be to secure funding at preferential rates so you can minimise your costs in the long run. Consider your working capital costs, VAT and any other charges, and bear in mind that banks typically won't lend more than 70% of the franchise start-up cost.

If you have enough cash, you may be tempted to fund all of the investment yourself if you think you could save money in the long term. However, this will expose you to much more significant financial risk, as there's no guarantee the business will be successful. Plus, you'll have less working capital to live off before you franchise becomes profitable and you can start drawing a salary from your revenue.

Other factors to consider

Remember that the more you borrow, the more interest you’ll need to pay back. However, when you finance part of your franchise with a loan and pay it back on time, you may be able to boost your credit score.

This could make it easier to get funding in the future, as a higher credit score could make you eligible for lower interest rates, whether you’re planning on financing another business or applying for a mortgage.

5 – How much will I make after 1, 2 and 3 years?

Many franchise brands will publish estimates of how much a franchisee could expect to earn after a period. These data must be based on real earnings reported by the network's current franchisees, although don't assume that every franchisee is receiving the same amount! As you might expect, the franchisor will want to make the best impression and will focus on the network’s best-performing businesses. Furthermore, when you see the phrase ‘up to’, this means you could earn the stated amount if you’re willing to put in enough time and effort. This may involve longer hours than you’re prepared to work, so make sure you have a realistic idea of how much you could earn based on how you want to run your franchise brands.

Bear in mind that the start-up costs will have a significant impact on how much you earn in the first few years. For example, if you're running a van-based franchise, the franchise fee may be much lower, and you won’t have to pay for an expensive office/commercial premises. Generally speaking, the lower the minimum investment, start-up costs and working capital requirements, the earlier you can become a profitable business.

6 – How long before I start making a profit?

It may seem a little direct at first, but this is one of the most critical questions to ask your franchisor. If you're financing a substantial proportion of the business with your own money, you'll need to know when you’ll start breaking even so you'll know how much working capital you'll need to live off before you can take home a salary. Your franchisor should provide a clear projection of when your business should start making a profit, which should be based on the performance of the network's existing franchisees.

Get independent advice before you sign the contract.

Before you make any commitments, make sure you understand the financial risks involved in setting up a franchise. If you’re new to this sector and haven’t run a business before, it can be easy to underestimate your franchise cost or the impact that the franchise fee can have on your profit margins. That’s why it’s essential to get independent advice from solicitors with expertise in the franchise sector. They’ll be able to run through the contract, highlight any potential issues, and answer any questions you may have about your investment and the risks involved. To ensure you receive the best advice, always hire a solicitor that’s been approved by the bfa.

Hopefully, all the above advice will prove useful.

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