This is one of the most common questions I hear from successful entrepreneurs who are considering franchising their businesses. Often, they’ll tell me that they’ve been told they need to have at least $100,000 in the bank. I don’t know where this number comes from or who has said it is true, but it is a persistent phenomenon. As with most things in life, the answer is “It depends.”
There are two kinds of costs that every new franchisor must address – up-front costs (call them “sunk costs,” if you like) and operational costs. “Up-front costs” generally include the costs related to setting up an entity to be ready to sell franchises. “Operational costs” generally include costs related to selling, opening and supporting franchises.
“Up-front costs” often include legal fees and franchise consulting fees. Both of these fees can be substantial – and depending on which professionals you retain, can easily amount to $100,000 all by themselves. But, they don’t have to. Many entrepreneurs are confident enough in their own marketing, sales, or business planning experience (to use a few examples) that they do not feel the need to hire a consultant for help with these aspects of starting a franchise company. And, if they are, the costs to hire a consultant for other aspects of the franchise roll-out – like advice on (a) establishing an appropriate multi-unit development structure, (b) site selection criteria, (c) planning for supply chain growth and management, and (d) developing an operations manual – can be reduced. In some cases, entrepreneurs decide not to hire a consultant at all. But, make no mistake, good franchise consultants are worth the money – if you can afford it.
The legal expenses involved in setting up a franchise system can vary widely depending on how complicated the franchise structure will be and in which states the company intends to sell franchises. Franchising is wonderfully flexible. It is possible to create a practically unlimited number of quirks and wrinkles in the relationships between the franchisor and franchisee. But, generally, the more numerous those quirks and wrinkles are, the more complicated – and expensive — the drafting process will be. For the purpose of illustration: a basic franchise structure involves a single franchisor and a single franchisee for the operation of a single unit of the business; one type of complicated structure involves a franchisor who grants to a master franchisee the right to offer, sell and provide support to franchisees in a particular area. The more people and locations involved in the structure of a franchise relationship, the more expensive the legal fees will be. Most start-up franchisors – even those with in-house counsel — don’t have the legal expertise in franchising to confidently tackle these issues on their own, so these costs are harder to manage. But, it is fair to say that, in the United States, it will probably cost at least $15,000 to prepare the legal documentation needed to start selling franchises. For complicated franchise systems, the costs could easily be $40,000 … or more.
Of course, your need for cash doesn’t end once you have a document you can use to sell franchises. You need to have cash available to cover your “operational costs.” Just to get a franchisee up and running, you may have out-of-pocket expenses for marketing, site evaluation and planning, and training services, among other things. Then, once the franchisee is operational, you will have other expenses related to supporting that franchisee. In an ideal word, the pre-opening “operational costs” would be more than off-set by the initial franchise fee paid by each franchisee and the post-opening “operational costs” would be more than covered by the ongoing fees (royalty, ad fund, software, etc.) paid by each franchisee. But, usually, there are economies of scale in providing these services to franchisees and the franchisor’s break-even point may not be reached until the franchisor has 5 or 10 or 20 units open and operating. So, the franchisor’s cash requirements can vary dramatically depending on extent of the services provided to the franchisees.
In the end, any new start-up franchisor will need substantial cash reserves. How much they will need depends tremendously on the people they hire and the services they provide to franchisees. Does it always cost at least $100,000 to start a franchise system? No. It can be done more cheaply than that – maybe even a lot more cheaply. But, as with all things related to money … usually, more is better.