When prospects try to find a franchise concept that aligns best with their goals, a major part of that equation will come down to the financial requirements. Franchising requires entrepreneurs to put down an initial investment, as well as to prepare for ongoing costs such as royalty payments and other fees. To find the specifics of these financial requirements, prospects should look to the brand’s Franchise Disclosure Document (FDD), specifically Items 5, 6 and 7. These items cover initial fees, other fees and the overall estimated initial investment.

The initial fee, found in Item 5, details the cost for ownership rights, also known as a franchise fee. There may also be additional “territory fees” for business models in which franchisees can service more than one city under one territory. Franchise fees are generally in the range of $20,000 to $50,000, depending on the brand.

In some instances, incentives or discounts are offered to benefit certain groups, for example, existing employees that buy the franchise, multi-unit operators that agree to open multiple locations, or a specific demographic, like U.S. armed forces veterans.

Item 6 details other fees where prospective franchisees can investigate elements like royalty fees, national ad and marketing fund fees, call center resources, training and audits. Essentially, this section lays out the cost of the “extras” that a franchise brand can provide, which independent business owners don’t need to worry about when they start a business.

Royalty fees, for example, are typically paid monthly to the franchisor and are based on a percentage of a franchisee’s revenue. These may be as low as 4% or as much as 12% or more, depending on the type of franchise concept. The royalty fee will be collected by the franchisor for the duration of the franchise agreement.

Item 7 provides a summary section for the franchisor to lay out a detailed explanation of all costs involved in the initial investment. The section is routinely presented as a chart that includes cost ranges for the various elements that involve cost. Franchisees have the option to invest the minimum value in the range to keep initial costs down, or invest high upfront in order to increase the return on investment in the long term.

Overall, the summary of start-up costs is a good way to assess the capital requirements for launching a franchise, while also assessing the minimum level of cash reserves needed for the first few months of operations. Franchisees should also go through a brand’s financial statements and get a copy of the franchise agreement and compare it, line by line, to what the FDD says.

When going through the franchise buying process, prospective franchisees need all the help they can get to make sure that the franchise is a fit on both sides. By understanding what items are most important in the FDD, franchisees are better equipped to make a sound decision.

Franchise Disclosure Document: Items 5-7

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Luca Piacentini