The Real Cost of Franchising Your Business Franchising can be a low-cost way to expand your brand — but it's not no cost. Here's what to keep in mind.
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Franchising is a great opportunity for business owners (franchisors) to expand their businesses by using other people's money. Franchisees will typically pay for all the startup costs for each new unit, easing the burden of the franchisor. This includes real estate, build-out, inventory and the negative cash flow of starting the new branch.
Even more beneficial to franchisors, 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, support and site selection.
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 dangerous if taken too literally.
While franchising is a low-cost means of expansion, it's not a no-cost means of expansion. As with most new businesses, one of the most significant reasons franchising fails is undercapitalization.
So it's important to remember that franchising your business is not extending your existing company, but instead, it's creating a new one. 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 franchisee 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?
How do you estimate costs?
Simply put – it depends. Over the years, consultants and pundits have floated all kinds of estimates for the costs involved in franchising your business. However, these estimates can vary considerably since franchising can be done in a number of different ways in a variety of industries. So how do you estimate your costs? Ask yourself how aggressive you want to be with your franchise expansion program and start with your legal and quality control costs.
Say, for example, you want to open one or two more units in your local market by franchising. In this scenario, you, as a prospective franchisor, need to determine your legal and quality requirements.
- Legal Costs. You'll want to retain afranchise attorney to develop your legal documents, guide you through any complexities, and assist with related work like licensing agreements and trademarks. You also may need to work with an attorney and CPA to audit your balance sheets and create a new entity. Depending on the state where you offer and open franchises, you may also need to comply with state registration laws that could increase your costs. You're maybe looking at a minimum of $25,000 for these costs.
- Quality Control. 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. You'll therefore need to create an operations manual to govern quality within the franchise system. The operations manual defines the standards of quality required and is incorporated directly into the legal contract between you and the franchisee. Creating this manual takes time and care – it will control quality, your liability, negligence, agency relationships and more. You are also looking at another $25,000 to get this done right.
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 about if you want to get aggressive?
If you're seeking to franchise aggressively, however, legal and quality control costs can increase significantly, and now you are adding in further costs.
- Legal cost increases. Legal expenses for a more aggressive rollout may include additional state registrations and more complex area development contracts. In all, the legal costs for a more aggressive franchise program can reach $50,000 or more.
- Quality control increases. Quality control will become both more cumbersome and more expensive with aggressive expansions. With more franchisees going through the system, there will be a need for a more formalized training program. This could double the costs of your quality control.
- Planning costs. A more aggressive growth strategy 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 its financial implications. 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. Planning costs, depending on the scope and consultants involved to assist, can easily break the $25,000 threshold.
Aggressive expansions come with financial risks
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% royalty seems small, that additional 1% could cost the franchisor $5,000 to $10,000, or more, per franchise sold. That "1% mistake," when multiplied by 100 or more franchisees and by five or more years on the contract, can easily mount into the millions.
Marketing your new franchise
Of course, the biggest difference between conservative and aggressive franchisors 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" with professionally designed materials and marketing campaigns.
- Brochures. A full-sized, four-colored brochure is virtually the cost of entry in modern franchising to demonstrate the credibility of the franchise to key influencers in the franchise selection process – accountants, attorneys, bankers, spouses and more. The design of a good brochure will cost between $7,000 and $10,000, and the printing specifications can add another $10,000.
- Mini brochures. Mini brochures are great tools for companies with physical units, or for companies that plan on using direct mail or trade shows to promote their franchise. This brochure, typically done in a two- or three-fold format, can be produced, in quantity, relatively inexpensively (around $5,000 total).
- Internet. A professionally designed website is 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.
- Videos. 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 can generally be developed for between $15,000 and $25,000.
- Marketing budget. Depending on the investment size of the franchise opportunity, you should budget between $5,000 and $7,500 (and in some instances more) per franchise to be dedicated to 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 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, you should have at least five to six months' worth of advertising money on hand – or about half your annual budget.
- Marketing research. To optimize these expenditures, you should also invest in primary market research 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.
You'll need a team
The single biggest investment you'll make while you develop your franchise is your people.
Most companies getting into franchising for the first time by leveraging their existing staff. Often, the business founder acts as the primary franchise salesperson and the staff supports the franchise with operational work and training. While this works in most growth scenarios, the more aggressive the growth scenario will require you to hire incremental staff to fill key roles in the areas of franchise sales, training and field support sooner rather than later.
But first, hire the salesperson
The first hire for the aggressive franchisor is generally the franchise salesperson. A proven franchise salesperson will need 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. You should expect the franchise salesperson to begin earning their keep by selling franchises relatively quickly (approximately 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.
Outside of the salesperson's salary, you'll probably have to hire an executive recruiter to locate this top talent – and those fees can get up to 25% of the first year's compensation. You can probably budget $75,000 in personnel costs before selling the first franchise, should you go this route.
Hiring for other roles generally comes after franchise sales have started and after the royalty stream is established. But again, the more aggressive the growth, the earlier these hires need to take place.
Conduct a 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. A cash flow analysis should account for all your hiring, marketing, legal and development needs, as well as 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 should require a cash flow budget of $250,000. This will be to fund development costs and franchise growth until franchise sales begin "paying for" incremental personnel and advertising needs.
Every franchise is unique, and so is yours
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 failed at franchising after investing far more.
While it is important to be properly capitalized to go about franchising, it is also important to remember that the costs of franchising, even in aggressive growth scenarios, are often less than the cost of starting just one more company operation. The investment in a franchise program can make you 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.
Related: Considering franchise ownership? Get started now and take this quiz to find your personalized list of franchises that match your lifestyle, interests and budget.