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.