Ask an Expert September/October 2017

Q. I’m thinking about buying a franchise. What do I need to know about the costs and fees involved?

A common dream for the working majority is to be their own boss. Often this is just a wish, but some get to the point of actively making a move, and may choose the safety net of operating their business as part of a franchise system.

Starting a new business can be cash intensive, so it is important to know what to expect when starting out. Your franchisor can give you a good idea of these needs, but it’s important that you also ask the right questions. Below is a rundown of some of the key costs that will drive your cash flow needs through the start-up phase of operations and beyond.

Initial franchise fees

When buying into a franchise system, the franchisor is providing you with the information you need to run a successful operation, including the initial training, operating manual, use of trademarks/tradenames and additional items such as secret recipes, products, and ongoing support. Terms and conditions surrounding the use of these insights and intellectual property will be outlined in the franchise agreement. The franchisor is compensated for providing this proprietary information through various fees, starting with the initial franchise fee, which is generally due upon the signing of the franchise agreement.

Franchise fees generally range from $10,000-$75,000, but may be more or less depending on the industry and franchise group. These agreements generally last between five to 10 years, at which time a renewal fee is payable, at a cost that can be up to the total initial amount of the franchise fee.

Start-up costs

Depending on the type of company you are planning to operate, additional start-up costs could include purchasing a vehicle with a logo, inventory or signage, up to building a complete store or restaurant including furniture, fixtures, and equipment.

Legal costs for incorporation, review of the franchise agreement, negotiation of a lease, and drafting employment agreements can add up, as well. There are also ongoing costs that may be incurred during a construction period, including utilities, first and last month’s rent deposits, training, and insurance.

In some circumstances, start-up costs can be significant, up to millions of dollars, so it’s vital to have a good idea of what to prepare for.

Ongoing fees

On top of initial franchise fees, many franchisees are charged a number of other fees to support the ongoing operations of the system. These often include royalties, which are normally between 5-8 per cent of sales, and advertising fees, which are generally 1-4 per cent of sales. Some brands also charge fees for local advertising funds or administration fees if the franchisor engages in services such as bookkeeping or other ongoing support costs on behalf of the franchisee.

Period of time before profitability

During the start-up phase, there may be weeks or months before the company begins to turn a profit. Each franchise system has a different variation on the ‘normal’ period before profitability. This timeline, and the anticipated losses during this period, can require significant additional cash flows in order to allow the company to operate through to profitability. Discuss this with the franchisor up front to have a reasonable expectation of the timeline that operations will need to be funded prior to becoming cash flow positive.

Personal working capital requirements

Franchisees often overlook their own cash requirements during the time period before profitability. Starting a new enterprise requires a significant amount of time and attention, which limits the ability to earn cash outside of the business. It is important to consider the amount of cash that will be left out of the business and used personally during the start-up phase until cash can start to be withdrawn from the company.

When discussing a franchising opportunity with a potential franchisor, ensure you discuss the different needs for cash upon start-up. A franchisor should be able to provide reasonable ranges for all of the noted costs in order to allow for adequate planning.

Although entering into the world of franchising can be daunting and cash intensive, with proper planning and solid communication with your potential franchisor prior to entering into a franchise agreement, the needs of the company can be effectively managed to minimize the risk of running out of cash.

Lyn Little
National Franchise Co-Leader
BDO Canada LLP

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