4 experts weigh in on financial considerations of a franchising model
Franchising can provide a pathway for an entrepreneur to expand the size of their business while also affording others the opportunity of business ownership. However, making the leap from an independent business to a franchise model requires several considerations, chief of which to the would-be franchisor may be the question of, “How much will this cost?”
The answer to that question is not a simple one. There is no flat rate or crystal ball to reveal the exact amount that must be spent to get a franchise off the ground – much less to invest properly to ensure its success.
“When people call up and ask, ‘How much is it going to cost me to franchise my concept,’ I tell them that I can give them the legal costs – but there is a lot involved. The first question is what type of franchise model are you going to have? If it’s a single unit model with just a franchise agreement and related agreements, then that will cost one thing – whereas if you are planning to do a master franchise or an area development agreement, those can cost more. You need to ask that question first up front,” said Patrick Maslyn, a franchise lawyer of Masyln Law.
Masyln added that oftentimes brands don’t have their trademarks protected, so that will require additional cost. He also noted that many franchisors need to determine if they have the skills required to effectively put together a manual for the execution of a franchise business. If not, then they will need to factor in costs to pay an expert to handle.
“An FDD [franchise disclosure document] is often more than 200 pages and an FA [Franchise Agreement] is generally 50-80 pages. These documents can take weeks to adequately draft and require the attorney to gain a full understanding of the business, its risks and its profit centers to ensure that the franchisor’s interests are adequately protected by the documents,” said Attorney Keith Gross with Gross Law Group, P.C.
Gross offers services tied to other ongoing costs associated with keeping a newly launched franchise running, such as legal expenses and costs tied to modifying documents and preparing closing packages as a franchisor begins selling units. He added that costs associated with advertising the franchise opportunity will be key to factor in too, as well as staffing needs to support a growing system.
“Franchisors need to do a lot of advertising to sell units as well as the standard advertising necessary to get clients for their franchisees,” said Gross. “Depending on the concept, a franchisor will likely need to maintain certain franchisor level staff positions to fulfill the franchisors contractual obligations to the franchisees.”
“We look at a number of factors when we talk with a company about franchising their concept,” said Jim Deitz, President of The Franchise Doctor, Inc., a Denver-based consulting firm with an office in Atlanta, Georgia. “Seldom do we recommend starting the process before they've completed a full year of operations, preferably three years. If the franchisee will run a small, 1-or-2-person business; is the prototype performing at a level to provide an owner-operator at least a pre-tax profit of $50,000 in the second year of operation (after paying royalties and other franchise-related costs)? Can a franchisee realistically start the business for an investment of $50,000 or less?”
Deitz added that the earnings of a franchisee must relate to the investment necessary to start a unit in a way that makes the investment attractive to would-be franchisees. Additionally, competitive advantages against independents of a similar size should be considered to decide if it’s the right time to franchise. In all cases, Deitz mentioned that his team performs a feasibility study to help the client understand the potential roadblocks to franchising their business and to estimate the success that they can expect in making that choice.
There are yet other costs to consider according to Mike Rosenthal, who heads up the Franchise & Business Opportunity Law practice group at Wagner, Johnston & Rosenthal, P.C.
“Base areas of an investment that a franchisor should consider are making certain that they have the operational and back office part of their business well-established and well-documented. They should also have a marketing plan in place that can easily be picked up and utilized by a unit franchisee to start their business,” said Rosenthal.
Finally, Rosenthal added that deciding where you plan to franchise the concept can make a huge impact on costs.
“Geography can play a significant role,” said Rosenthal. “If a company is located in a state or states which require registration in order to sell franchises, that will increase the cost to franchise. Additionally, if the plan is to offer in other registration states, that will drive up the cost as well. Not to be ignored are the delays that many states effectively impose on offering franchises through a time-consuming registration process, which can take months.”