Opinions expressed by Entrepreneur contributors are their very own.
The next excerpt is from Mark Siebert‘s ebook The Franchisee Handbook: Everything You Need to Know About Buying a Franchise. Purchase it now from Amazon | Barnes & Noble | Apple Books | IndieBound
Whereas each merchandise on the franchise disclosure document (FDD) is necessary, some could also be extra necessary to you than others. One of many big-ticket gadgets you need to be listening to is cash: what you should put into the franchise and what you get in return.
It will be marvelful if there have been a easy calculation to determine your value benefit, however there simply is not. Sadly, as a result of the FDD is such a fancy doc, many potential franchisees attempt to simplify it, and nowhere is that this extra obvious than within the gadgets coping with charges and companies (Gadgets 5, 6, and eight).
Ceaselessly, potential franchisees will concentrate on both the franchise fee or the royalty and examine it to the opponents’. At a look, the bottom charge appears probably the most engaging. Sadly, that is the equal of going to a used automotive lot and shopping for the most cost effective automotive you could find.
Associated: Smart Tips for Successfully Navigating the Initial Franchisor-Franchisee Interview
Concentrate on royalties
It is an enormous mistake to make your funding resolution based mostly on the preliminary franchise fee alone. Whilst you need a franchise charge that is cheap and aggressive, it is just one part of your complete funding, and in most franchises, it represents a comparatively small fraction of that funding.
For many franchisors, the preliminary charge is not a big revenue heart. They’ve prices related to advertising and marketing the franchise, franchise gross sales, authorized documentation, coaching their franchisees, and offering them with preliminary help till they’re up and working — all of which is theoretically lined by the franchise charge. So, whereas charges within the tens of 1000’s of {dollars} simply to hitch the system could seem extreme, this is not the place the franchisor makes its cash.
Royalties needs to be far more necessary in your decision-making course of. As an example you select to pay a royalty that is one p.c larger than the charge of a comparable franchise providing. On gross sales of $500,000, that represents an extra $100,000 all through a 20-year settlement.
However procuring based mostly on royalty alone is not the reply, both. For those who have been to go to that very same automotive lot and somebody have been to give you a ten-year-old Chevy for $50,000, you’d assume they have been loopy. But when they provided you a brand-new Ferrari for that very same worth, you’d bounce at it. The true query, then, isn’t worth, however worth.
Associated: Never Buy a Franchise Without Researching These 5 Sources
Perceive the charges
At this level in your evaluation, although, do not attempt to assess the value. Simply have a superb understanding of the charges you are prone to incur. Along with the preliminary charge (present in Merchandise 5), Merchandise 6 of the FDD gives you with a desk documenting all of the charges the franchisor will accumulate from you. So, if the franchisor has a 5 p.c royalty and a 1 p.c know-how charge, you’d pay a complete of 6 p.c. Undergo this part intently to find out precisely what your commitments might be.
Additionally, ensure you perceive how these charges are literally calculated. For instance, whereas most franchisors cost franchise charges based mostly on gross sales, some cost royalties based mostly on gross revenue (revenues minus the price of items offered). Some franchisors might have completely different definitions of “product sales” — for instance, excluding taxes or reward card revenues.
The one set of charges you could need to view otherwise as a part of this evaluation are your advertising fees, referral charges, or nationwide accounts prices. Not like most different charges, these charges are geared towards driving income to what you are promoting. As such, it’s best to view them as non-incremental (as presumably, the franchisor has designed them); they’re going to profit you straight and are based mostly on the franchisor’s evaluation of what is been traditionally essential to drive enterprise to your door.
That is additionally a superb alternative to try Merchandise 8 of the FDD, by which the franchisor should disclose any restrictions on the sources of services or products that might be imposed on you. Any franchisor that is trying to management high quality will dictate the sources of any services or products that may impression the integrity of the model — and that finally impacts your prices, charges, and backside line. Frankly, it is typically in the perfect pursuits of your complete community to make sure that the franchisor enforces these model requirements.
Associated: Which Franchise is Right For You? Follow These Steps
Merchandise 8 disclosures
Every now and then, the franchisor could also be one in every of a number of suppliers and even the only designated provider of sure services and products. Many franchisors will select to promote merchandise and/or companies to their franchisees. This may even be disclosed in Merchandise 8, together with the income (not earnings) that the franchisor or its associates derived from these purchases. Item 8 can be the place the franchisor discloses any rebates or different incentives it receives from designated suppliers.
When the franchisor sells to you, it ought to have the chance to make an affordable revenue from these gross sales. In lots of techniques, the revenue a franchisor makes on product gross sales might permit it to scale back the charges it prices in different areas, similar to royalties. Likewise, we have seen a number of franchisors who will redistribute producer’s rebates to their franchisees or who will contribute some or all of these rebates into their promoting fund for the good thing about all franchisees.
If the franchisee is performing as a captive channel of distribution for the franchisor, make an observation of it right here. Later in your diligence course of, you may ask any franchisees you interview whether or not the franchisor’s pricing is affordable.
