Picking the right franchise requires a hefty dose of due diligence and a healthy bank account. But if you are willing to do your homework and make the investment, a franchise purchase gives you the right to sell the franchisor’s goods or services and access an established company's brand name, operational know-how, and marketing.
Do Your Due Diligence
The most successful franchise owners perform a thorough and strategic analysis of the franchise’s history, organization, operations and finances. (For more, see: When is a Franchise the Right Investment for You?) While you can buy a franchise on your own, consider hiring an accountant or qualified financial advisor for expert advice. Analyze the franchisor’s financial statements to ensure that existing capital is sufficient to keep the chain running smoothly and if the parent company is profitable and will have the resources to invest in its franchises. For example, it could be a red flag if a franchisor leans too heavily on start-up investments to fund their operation. Examine the franchisor’s earnings claim statement or sample unit income (profit and loss) statement, as well as the company’s audited financial statement and a list of current assets and liabilities. (For more, see: Definition: Franchise Disclosure Document.)
Analyze the expected three-to-five year cash flow after factoring your costs for labor, marketing, royalties, and raw materials. Determine if current franchises are turning a healthy profit by interviewing current franchisees about their yearly earned income relative to expenses.
Have Your Checkbook Ready
Every franchise has a franchise fee: a one-time entry cost that gives you access to the franchise's brand, operating systems, marketing and training. Franchise start-up costs vary wildly. Some of the fastest-growing and most-successful franchises can be the best deals. For example, Jan-Pro International, the second fastest growing franchise in Entrepreneur's 2020 Fastest-Growing Franchises Ranking, requires an initial investment as low as $4,000. Jan-Pro offers commercial cleaning services to businesses such as car dealerships, gyms, banks, churches, schools, and offices. You can invest in Cruise Planners and Stratus Building Solutions, numbers four and seven on Entrepreneur's 2020 list, for as little as $2,000 and $4,000 respectively.
Investing in a top brand costs significantly more. The initial investment in McDonald's, the franchise with the greatest brand strength, according to Entrepreneur, is between $1.3 million and $2.2 million.
Dig into the details beyond the franchise fee to understand exactly what you'll receive, such as administrative support. Will you need to do your own business development or will the franchisee supply you with customers or prospects? In addition to initial fees, consider the other start-up costs and asset requirements that many franchises require. While Denny’s Corp. (DENN) has a deceptively modest initial actual fee of $30,000 as of 2020, potential franchisees must demonstrate robust assets: $1 million net worth and at least $500,000 in liquid capital.
While startup costs and earning potential are obviously crucial factors to consider, also take a hard look at the failure rate. Plenty of first-time franchise owners have defaulted on SBA loans for franchises that have failed to thrive — and you might be surprised to find out which ones are the guilty culprits. Do your homework.
The Bottom Line
It’s fine to window shop on your own, but you’ll likely want to hire a financial advisor or accountant to help you perform a thorough analysis of a potential franchise investment. While your available capital and loan options will determine the initial franchise fee you can afford, start-up costs are just one of your initial considerations. From reviewing the franchisor’s financial formula, legal records and earning statements to interviewing current franchisees to get a realistic picture of expenses, profits and other operating concerns, your franchise analysis will require you to cast a net that’s both wide and deep.