Q: I've been reviewing franchise companies, and I'm confused by the data they provide in the UFOC concerning startup costs. There seems to be a large range of expenses in each category, and they use terms like "Working Capital Reserves" that I don't understand. I also notice that some of them require that I buy my equipment and supplies from them. Is this a good deal for me?
A: The information in the UFOC is designed to give you a range of possible startup expenses that represents everything from the smallest to the largest total that these costs may represent to get your new franchise up and operating profitably. This information is just the starting point in determining what your total investment will be. You'll need to refine this data through your conversations with the franchisor and the existing franchisees to come up with an accurate number for your situation.
Working capital reserves are an important component of your startup costs. Most new businesses lose money on their operations for some period of time after they first open. You'll need to have extra money put aside to cover these losses. The working capital reserve figure in the UFOC is an estimate of the total extra money you'll have to have available to reach the point in time where an average new unit in that system reaches the breakeven point in terms of current operations.
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Your last question is one that you need to be very careful about. One of the greatest advantages of a good franchise is that the franchisees can use their combined purchasing power to save lots of money on supplies and equipment for their businesses. You want to make sure that this is the case in any franchise you investigate.
Most franchise companies do not require franchisees to make all their startup purchases directly from the franchisor. If they do, it's not necessarily a problem, but it does raise a red flag. The key point to determine is whether this requirement stems from a desire to save new franchisees time, effort and money during this process, or whether this is a hidden profit source for the franchisor.
You have to investigate to find the answer. The easiest source of information is the existing franchisees. You'll want to discuss startup costs with them anyway to help narrow the range for your own situation. While you're at it, just ask if the pricing of the required purchases is reasonable and represents cost savings for the franchisees. If it's not, I assure you, you'll get an earful. Nothing irritates a franchisee more than learning that the piece of equipment they paid the franchisor $20,000 for is readily available in the open market for much less. This type of rip-off (pretty strong word but accurate) is nothing more than a disguised effort to increase the initial fee you are paying to join the system.
You also need to ask about ongoing supply items needed in the operation of the business. If the franchisor is distributing these items at a cost greater than the open market price, it represents a disguised effort to increase the royalty fee you are paying to operate in the system.
I believe in the open disclosure of all fees and costs you pay to be part of a franchise system. In a good franchise, these are well-worth the expense because of the overall success you will enjoy as a franchisee. I've never seen a franchise I would consider good that is hiding unwarranted distribution profits they make off their franchisees. You need to check this factor carefully as part of your investigation of any franchise company.
Jeff Elgin has almost 20 years of experience in franchising, both as a franchisee and senior franchise company executive. He is currently the CEO of FranChoice Inc., a company that provides free consulting to consumers looking for a franchise that best matches their needs. He can be reached at jelgin@FranChoice.com.
The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.