So, you’ve decided to open your own franchise business. The I’s have been dotted, the T’s are all crossed and a careful scouring of your brand’s Franchise Disclosure Document has you all up to speed on the financials for opening your first location. However, there might be something important you missed, something that even a careful reading of an FDD won’t uncover: you might just not have enough working capital to get the business off the ground.
That is because even in the carefully regulated world of franchising, requirements for brands to list working capital are limited to only a three month period. And according to the experts, that is often not nearly enough of a cushion to prepare franchisees for what the first year in business will really look like.
“The biggest mistake I see is that people completely underestimate the amount of reserve capital that will be required,” said managing partner and founder of The Internicola Law Firm, Charles Internicola. “Reserve capital requirements estimated by franchisors in FDD Item 7 are typically limited to 3 months, which 99 percent of the time is insufficient. Franchisees need to plan on possessing more reserve capital than most franchisor's estimate in their FDDs.”
So, how many months’ worth of working capital is actually necessary for a successful launch? It really depends upon the business and the market, though there are a few minimums to keep in mind.
“There are no hard and fast rules because the amount of required working capital will vary depending on a number of personal and business factors,” said Internicola. “But you must plan for at least an eight month cushion of available working capital to ensure that your marketing and business development will stay on track.”
According to Sean Fitzgerald, 1851 Magazine's chief development strategist, a lot depends on the specific industry you are in.
“Restaurants start strong, but the service industry is usually a slower ramp up and might take longer to break even,” said Fitzgerald. “So, you need to know what business you are in and have enough capital to cover expenses until you reach that point.”
At the end of the day, though, Fitzgerald says the best course of action for any franchisee is to ask as many questions as possible, including seeking outside validation of a brand before getting started.
“So many first time franchisees just don’t know, and they don’t even know to ask,” said Fitzgerald. “It comes down to validation as well, since brands do not have to answer beyond what is required in the FDD.”
It may not be a comforting or easy answer for franchisees to hear, but the fact remains that every business and every market is unique, and a one-size-fits-all approach is just not feasible.
Said Internicola, “Determining the right amount of capital requires a balancing of personal cash flow factors and business factors, but having sufficient working capital is one of the most important indicators for franchisee success.”