6 Financial Questions to ask BEFORE you invest in a Franchise


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So, you're thinking about becoming a franchisee? Congratulations! This huge, exciting step can be a defining moment in both your life and your financial future. The benefits of franchising are undeniable and its ability to make dreams come true is unrivaled. However, it can also be a major financial commitment - it's like buying your first house, sending your kids to college or planning for retirement, and sometimes it may even feel like all three of these at once. To be successful, it is vital to plan ahead, get your financial questions answered, and have realistic expectations about the time it will take to start seeing a profit.

So... Here are the TOP 6 financial questions to ask--and get answered--before buying a franchise:

This is undoubtedly the single most important question you will have and it's likely the first one you'll ask. It may also be one of the hardest questions to get answered. Let's first look at why this question is so hard to answer and then give you some resources for finding that information. By law, franchisors are not legally required or allowed to share financial performance information unless they have verifiable earnings information on their franchisees as a group or groups. If available, it will be found in Item 19 of the Franchise Disclosure Document ( FDD ). It may be listed in many different formats such as average revenue, average costs, average net profits or others. You should count on the franchisor to help you understand how they arrived at these numbers.

Many times it helps to make a list of your objectives, prioritize your questions and then set out to learn the answers. Perhaps a better question to start with is: What are my short and long term goals? Are you trying to replace income immediately or are you interested in building long term wealth? If you answered "immediately replace income," then you might want to look for a business that has the ability to generate cash quickly such as product and/or service sales. If the business doesn't require large investments of time, energy and dollars then a significant portion of what you sell is immediately put to your bottom line.

If you are approaching this as more of a long term investment, then searching for the business that has long term recurring revenue streams might be for you. Make no mistake - all franchise investments come with risks. It is your responsibility to know what they are and understand your own risk tolerance. This will make it easier to decide what kind of franchise is best for you.

The best resource for getting the money question answered is existing franchisees, particularly those who have been in business for several years or more. Talk to as many of these franchisees as you can; don't be afraid to ask them when they started seeing a profit and how they currently generate new and profitable customers - maybe they'll even share a few insider tips for you!

The reality is that your business probably won't make money during the start-up phase and, for the typical franchisee, this phase lasts for the first 1-2 years. Just like any new business, it takes time to build up your customers or clientele, find your marketing niche and get into the groove of running a business. On the upside, the franchisor can usually provide a range or the average time most of their franchisees reached the break-even point. That said, it's best to err on the side of caution; plan for the longest amount of time in the range and try to overcompensate for averages. Lastly, use your newfound franchisee network! The folks you looked to for answers in the last question will be just as helpful in answering this one.

Now that you have a better idea of how long it could take to see a profit, it's important to consider your upfront costs carefully. Remember, your upfront costs include both buying and running the business until it makes a profit. The franchisor will give you a general guideline in the estimated investment section (Item 7) of the FDD, but existing franchisees are still going to be your best resource. As always… Overcompensate! You'll only be able to estimate the actual startup costs, so make sure you'll have enough working capital.

Working capital (a.k.a. operating capital) is the money you'll need to run your new business until your business starts making as much money as you are spending. This includes both operating expenses (such as your marketing costs, cost of employees, cost of equipment and utilities, etc.) and your personal living expenses. Since the break-even point could take longer than expected and your expenses could be greater than expected, an extra cushion of capital is a smart idea.

It is not uncommon for many new franchisees to finance their new business through various and sometimes multiple sources. Check with the individual franchisor first to learn about any financing opportunities they may have available. It is also not uncommon to secure finances via a loan from a local bank (typically these loans will need a guarantee such as personal collateral, like your home equity), family and friends or by taking on a business partner who can financially support you through the start-up phase. There are also companies who will help you borrow money from your own IRA or 401(k) accounts, without early withdrawal penalties, to finance a franchise business. It's important to keep in mind that, no matter how you choose to finance your new business, franchisors and banks will require that a portion of the overall investment is met by you in cash. This is often referred to as "having skin in the game." As a general rule, businesses are more likely to be successful when those running it have a personal investment.

Whatever means of financing you use, keep in mind two things:

1. It's never too early in the research process to begin looking at your financing options
2. Having good credit and cash in the bank are always good ways to prove financial stability.

This may not be a question you've thought of, but it's truly the most important question you can ask. We've all been reminded in the past few years how dramatically the economy can fluctuate and when you're buying into a franchise, that company's financial stability can and will affect your bottom line. Companies that are financially strong will be able to support the franchisees and will be better prepared for both economic shifts and the long term. These companies are equipped with the necessary tools and resources to continually build the brand and make changes to the product / service / operating system as needed. This will give your franchise a competitive advantage and keep your profit margin consistent. The franchise's FDD will include their financial statements. When in doubt, make sure to ask your financial advisor for help.

Getting these financial questions answered is a pivotal step in your franchise research. Take your time. Ask each and every question, talk to as many people as you can and do your research. When you find the right franchise, you'll be confident in your purchase and ultimately more successful.

Here's to your success and best of luck!

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Referenced Stocks: FDD

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