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How To . . . figure out franchise start-up operating costs

For anyone thinking of starting a new business, the most important piece of information is the amount of capital they'll need. Besides the initial investment for land, building, furniture, fixtures and equipment, the new entrepreneur has to purchase inventory, supplies and a host of other essentials just to open his or her doors. But, having enough money to open isn't usually sufficient. Entrepreneurs also need money to keep the business up and running until it can support itself. Running out of working capital is probably the single biggest cause for new businesses failing. If the only benefit you receive from joining a franchise system is the ability to project the start-up capital you need, paying the initial franchise fee will have been worth it.

Without the knowledge that comes from a mature franchisor, you'd have to research equipment suppliers, work with architects and décor designers, determine site requirements, locate vendors and on and on. Of course, without a base of reference and advice from someone who's gone through the process before, finding all the resources to get this done takes a lot of time. And, for anybody starting a business, time is a very expensive commodity.

Franchising provides new franchisees with two resources for determining start-up costs:

1. Existing franchisees in the system. Franchisees who have recently developed new locations can provide real time estimates of what's required. Even with information provided by the franchisor, smart prospective franchisees will talk to experienced franchisees to confirm what the franchisor estimates.

2. Item 7 in the franchisor's Uniform Franchise Offering Circular. Every franchisor is required to prepare and deliver to prospective franchisees a copy of its disclosure document-the UFOC. Contained in the UFOC is the franchisor's estimate of the initial investment new franchises require, including the working capital needed during the early months of operation.

If you're buying a franchise or starting your own business, some items you should be prepared to estimate include:

  • The cost of finding the location. Even if the landlord pays the real estate agent's commission, you'll probably incur the cost of market research, including demographics, traffic studies and competition.
  • Security deposits. Expect everyone to require a security deposit-the landlord and the utilities will probably be the first to ask.
  • Professional fees. Building a new location or remodeling an existing one requires architectural plans. Plan on spending some money on engineers as well. Plus, if the site isn't zoned for your type of business, you may need lawyers and other professionals to help you with the zoning board.
  • Site preparation. You'll have to pay a contractor to build it as well as the cost for equipping the location with signage, furniture, décor packages and landscaping. Everything you put into the site will probably come by truck, so plan on freight costs and sales tax as well.

Once your location is ready for occupancy, you still have a few costs to estimate:

  • Opening inventory and supplies: Raw materials, paper supplies, cleaning supplies, smallwear (utensils, etc.) and everything you need to prepare your products or services.
  • Insurance: Not just property and casualty insurance, but worker's compensation and, if you have a vehicle, auto insurance as well. Your insurance broker will probably ask for all or part of your first year's premium as a deposit, in advance.
  • Computer power: Point of sales and hardware and software. If you can't find software that's right for your business, plan on professional fees to have someone develop it for you.
  • Other professional fees: Besides architectural and engineering fees, a lawyer and an accountant to help you establish your business, negotiate with the landlord and zoning board, etc.
  • Pre-opening labor: Managers and staff hired before the business opens to get adequately trained and help you set up.
  • Working capital: The amount of money you need on hand to pay bills not covered by the cash that comes in. Depending on your business, you may need working capital to get you through the first few weeks, but many businesses require additional capital well into the first two or three years.

When it comes to estimating start-up capital, live by the saying "Hope for the best, but plan for the worst." Base your plans on realistic expectations, not pie-in-the-sky wishes. While the franchisor projects your opening capital requirements in its UFOC, these are usually based on system averages. Your location will likely differ in some way from the average. It may be a larger site in a more expensive area or your labor costs or sales may not be what the franchisor expects. Smart franchisees investigate the costs in their area and modify the franchisor's projections according to the reality of their markets. Don't blame the franchisor if you don't do your homework.

Michael H. Seid is managing director of Michael H. Seid & Associates, a West Hartford, Connecticut- and Troy, Michigan-based management consulting firm specializing in the franchise industry. Seid recently co-wroteFranchising for Dummies (IDG Books) with Wendy's founder Dave Thomas.

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