One of the greatest advantages of franchising is that it allows
business owners to expand their business using "Other
People's Money." Franchisees typically pay for all the
startup costs for each new unit. Real estate, build-out, inventory
and the negative cash flow of starting a franchise are all borne by
the franchisee. What's more, the franchisee typically pays the
franchisor an initial franchise fee that helps defray the
franchisor's cost of providing any initial assistance (such as
training, site selection assistance, initial support, etc.).
This system is extremely powerful, as it essentially frees the
franchisor from capital constraints--and allows the franchisor to
open franchises virtually "as fast as they can sell
them." But that last sentiment, while true in some respects,
can be a very dangerous sentiment if taken too literally.
While franchising is a "low cost" means of expansion,
it is not a "no cost" means of expansion. And, as with
most new businesses, one of the most significant causes of failure
for new franchisors is undercapitalization.
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One of the most important things to remember when making the
decision to franchise is that you are creating a new business--not
simply an extension of your existing business. Regardless of the
business you started in, you need to understand that franchising is
the business of selling and servicing franchisees. And your first
and most important priority must be to make your franchisees
successful.
While this new business allows you the ability to grow very
quickly in a highly leveraged way, you still need money to make
money. So how much is enough?
The 31 Flavors of Franchising
Over the years, we have heard consultants and pundits float all
kinds of estimates for the costs involved in franchising your
business. Unfortunately, these estimates can vary considerably.
This is due, at least in part, to the fact that franchising can be
done in a number of different ways. The bottom line: The most
important factor you should take into account when estimating the
costs of franchising is the aggressiveness of the desired expansion
program.
Say, for example, you want to open one or two more units in your
local market by franchising. Perhaps you're looking to provide
an opportunity to your relatives or existing employees. Perhaps you
only have modest expansion goals.
In this scenario, you, as a prospective franchisor, need only to
figure out two basic costs: legal and quality control.
Legal Costs. You should retain an attorney who is a
franchise specialist, as this area of the law is highly regulated
and complex. From a legal standpoint, an inexpensive attorney
specializing in franchising might develop your basic legal
documents (franchise agreement and Uniform Franchise Offering
Circular) and other related work (trademark protection, license
agreements, etc.), for as little as $25,000. Depending on the state
where you offer and open franchises, you may also need to comply
with state registration laws that could cost several thousand
dollars more.
You'll probably want to create a new corporation and need to
have a CPA conduct an opening audit of that company's balance
sheet (up to three years of historical audits are required if the
existing company will be the franchisor, but most new franchisors
opt for the creation of a separate franchise entity for a variety
of reasons). And while certain states look askance at a weakly
capitalized franchisor, in nonregistration states, there are no
laws or guidelines governing initial capitalization, so a couple
thousand dollars might cover the creation of this new entity.
Quality Control. Despite a desire for conservative
growth, you still want to control quality--after all, you've
built your name and reputation over the years with painstaking
care, and you won't want to take a chance on hurting your
existing business by allowing the brand to suffer. Thus, you need
to create an operations manual that will be the governing document
controlling quality within the system. Without this operations
manual, you run significant risks relative to brand maintenance, as
the operations manual defines the standards of quality required of
the franchisee, and is incorporated directly into the legal
contract between franchisor and franchisee.
While some entrepreneurs choose to develop their own operations
manuals internally, this path carries certain risks. The operations
manual, if properly crafted, not only controls quality, but also
limits the franchisor's liability relative to the acts of the
franchisee and the franchisee's employees. To do that, the
operations manual needs to cover not only day-to-day operations,
but a wide array of topics, in a way that does not create
incremental liability through negligence or inadvertently creating
an agency relationship. But even if you were to create a
professionally developed operations manual using a company such as
mine, the costs of developing this manual would likely run under
$25,000.
So to sell a few franchises locally, the documents needed to get
started could be developed for about $50,000. But what if you have
more aggressive growth plans?
How High is "Up"?
If you're seeking to franchise aggressively, however, these
costs can increase significantly.
Legal Costs. Legal expenses for a more aggressive rollout
may include additional state registrations and more aggressive
and/or complex development contracts (area development contracts,
area representative contracts, etc.). There are 14 registration
states and a number of business opportunities states--each has
franchise registration fees aggregating somewhere north of $6,000,
not including the incremental legal costs your franchise attorney
charges you. All told, the legal costs for this more aggressive
franchise program can reach $50,000 or more.
Planning Costs and Consideration. A more aggressive
growth strategy, by its very nature, also requires additional
planning. While a company planning on conservative growth can
probably get away with a fairly informal planning process,
aggressive growth dictates a thorough understanding of the
competitive environment and the financial implications of each
business decision. You need to build these financial and structural
decisions on a solid understanding of the organization, and know
the costs of building that organization in terms of people and
capital.
The aggressive franchisor must bear in mind that even seemingly
small mistakes, when multiplied by hundreds of franchisees, can be
the difference between success and failure. Take royalties, for
example--while the difference between a 4 and 5 percent royalty may
seem small, that additional 1 percent could cost the franchisor
$5,000 to $10,000 or more per franchise sold. That "1 percent
mistake," when multiplied by 100 or more franchisees and by
five or more years on the contract, can easily mount into the
millions.
Unfortunately, this more thorough planning process can be quite
expensive. Depending on the nature and scope of research conducted
on the market and on competitors, the amount and complexity of
financial planning, and various other factors, the costs of hiring
a consultant to assist in the development of these plans could
range between $25,000 and $35,000. In more complex situations, this
planning can become significantly more expensive.
Quality Control. With more aggressive expansion plans,
quality control will also become both more cumbersome and more
expensive. With more franchisees going through the system, there
will be a need for a more formalized training program, and perhaps
training videotapes and other training tools. Again, this could
double the costs of your quality control.
Marketing Your New Franchise
Of course, the biggest difference between the conservative and
the aggressive growth franchisor is in the areas of franchise sales
and marketing. While the conservative franchisor will be content to
let prospective franchisees come to him and operate in a reactive
fashion, the aggressive franchisor will want to "make it
happen."
Brochures. Your marketing efforts start with the
development of professionally designed materials. A full-sized,
four-color brochure is virtually the cost of entry in modern
franchising. This brochure not only sells the franchise opportunity
to the prospective franchisee--it also plays a key role in
demonstrating the credibility of the franchise to key influencers:
accountants, attorneys, bankers and spouses, who will play a key
role in the franchise selection process. The design of a good
brochure will cost between $7,000 and $10,000. Printing this
brochure, depending on print process, paper quality, quantity
printed, and a variety of design specifications (full bleeds on
pages, dye cuts, stapling, etc.), will cost another $8,000 to
$10,000.
For companies with physical units, or companies that plan on
using a lot of direct mail or trade shows to promote their
franchise, another great tool is the mini-brochure. This brochure,
typically done in a two- or three-fold format, can be produced in
quantity relatively inexpensively (design costs and printing costs
totaling around $5,000), and serves as a lead generator more than
as a credibility piece.
Internet. A professionally designed website is also
essential. In addition to franchise information, your website
should be equipped with lead collection forms and, ideally, an
autoresponder matrix that helps you sort the wheat from the chaff.
And this site needs to be optimized for franchising. While websites
are increasingly less expensive to create, you should still budget
$10,000 to $15,000 for a really good one.
For franchisors looking for more aggressive growth, franchise
sales videos are increasingly important in the sales process, as
streaming video becomes a more integral part of the internet.
Professionally produced videotapes promoting the franchise offering
can generally be developed for between $15,000 and $25,000.
Marketing Budget. At least as important as the marketing
materials will be your marketing budget. Depending on the size of
the investment in a franchise opportunity, you should budget
between $5,000 and $7,500 (and in some instances more) per
franchise to be sold to a promotional budget. If you're
planning to sell 20 franchises in your first year, an annual
marketing budget of between $100,000 and $150,000 is not at all
unrealistic. Of course, some of these funds will be recaptured as
you begin to realize franchise fee income, but since it takes an
average of 12 weeks to sell a franchise, as an aggressive
franchisor, you should have at least have five to six months worth
of advertising money--or about half your annual budget--on hand
when you get started.
To optimize these expenditures, you should also invest in
primary market research (to better understand your prospective
franchisee) and in a first-rate marketing plan. While inappropriate
for more conservative franchisors, these planning activities will
add another $10,000 to $15,000 to the budget.
Hiring a Sales Force
But the single biggest investment you'll have in the
development of an aggressive franchise company will be in your
people.
Most companies getting into franchising for the first time do so
by leveraging off of their existing staff. Often, the business
founder acts as the primary franchise salesperson, with support
from staff in the areas of operations and training. And while this
works in most growth scenarios, the more aggressive the growth
scenario, the sooner you should plan on bringing on incremental
staff to fill key roles in the areas of franchise sales, franchise
training and field support.
The first hire for the aggressive franchisor is generally the
franchise salesperson. A proven franchise salesperson will
generally command a compensation package in the low six figures,
with at least some of this package being performance based. Top
franchise sales pros can command twice the salary or more--but are
generally worth their weight in gold. Again, you should expect the
franchise salesperson to begin earning his keep by selling
franchises relatively quickly (a good franchise salesperson should
be able to sell 12 to 20 franchises per year), but you should
anticipate the need to fund at least four to six months of their
salary without any fee income. Add to this salary the fees
you'll pay to an executive recruiter to locate this top talent
(who will generally command a fee of 25 percent of first year's
compensation), and you can probably budget $75,000 in personnel
costs before selling the first franchise, should you go this
route.
Other hiring generally comes later--after franchise sales have
started and the royalty stream is established--but again, the more
aggressive the growth, the earlier these hires need to take
place.
Cash Flow Analysis
While this article provides an overview of the costs of getting
into franchising, the best way to get a reasonable understanding of
all these costs is to develop a cash flow analysis that accounts
for all your hiring, marketing, legal and development needs, as
well as for the inflow of franchise fees, royalties and other
sources of income. While many factors will influence your ultimate
cash need, a good rule of thumb is that an aggressive franchise
program may require a cash flow budget of $250,000 to fund
development costs and franchise growth until franchise sales begin
"paying for" incremental personnel and advertising
needs.
But remember, rules of thumb, like thumbs in a softball game,
are often broken. Many franchisors have succeeded in growing
significant franchise companies with far less--while others have
failed at franchising after investing far more.
While it is important to be properly capitalized to franchise,
it is important to remember that the costs of creating this
franchise company, even in aggressive growth scenarios, is often
less than the cost of starting just one more company operation.
That investment in a franchise program can grow to be a franchisor
with hundreds, or perhaps thousands, of franchised units, providing
you with leverage not found in any other means of business
expansion.
Mark Siebert is the "Franchising Your Business"
coach at Entrepreneur.com and is the founder and CEO of
iFranchise
Group Inc., a consulting company that helps businesses assess
their franchising potential and develop and improve existing
franchise systems.