How to Avoid Franchise Undercapitalization

What can I do to help avoid undercapitalization?
As you already know, opening a franchise business is a safer bet than opening your own business from scratch. Still, even a franchise isn’t a sure thing.

One of the biggest mistakes that people make in opening a business is starting undercapitalized. The good news is that making sure you have enough money to get to the starting line (opening your business) AND the finish line (running a business that meets your financial and life goals) is almost completely within your control. All you have to do is be willing to learn from others.

Remember, when you join a franchise system, you’re joining a group of people – your fellow franchisees – who’ve already been down the road you’re about to travel. If you are willing to learn from their experience, and you’re willing to put your desire to open for business tomorrow on hold while you do your research, you’ll reap the dividends for years to come.

Before you do anything else:

Accept that it can happen to you. This is really the first step. Once you accept that your business could fail due to undercapitalization, you are much more likely to do your homework. And the more homework you do, the more likely you are to succeed.
Be willing to learn from others. Remember, part of the reason you are considering a franchise is so that you don’t have to do it all on your own. So let some other people help you. Learning from the experience of others is a lot wiser – and less painful – than learning from your own mistakes.

Before you sign your franchise agreement:

Do some basic research. Franchisees are the single best source of information regarding startup and operating costs. They can tell you about the unexpected things that drove their costs up, as well as tips for cutting costs and increasing profitability. Also, don’t underestimate the wealth of information and resources that are available on the internet, and on the International Franchise Association website (www.franchise.org).
Get help. There are plenty of places where you can go for help. Start with SCORE (www.score.org). It’s free, it’s in most cities in the country, and even if your counselor doesn’t have specific franchising experience, they can still help you with the basics of business planning and budgeting.
Build some high-level budgets and financial models. Once you’ve narrowed your choice for franchise systems down to the most appealing, build some high-level budgets and financial models. Do this for each of the franchises you are considering. This will help you better understand the potential risks and rewards for each franchise you are considering. Your accountant or consultant can help you with this.
Run your budgets and financials past existing franchisees. Ask them to tell you if they think your numbers are realistic. Be sure to choose a mixed group – some who are doing well, some who are doing okay, and some who are doing poorly. It will give you a well-rounded picture of what to expect.
Have an accountant review your high level budgets and financials. Ideally, choose an accountant who is familiar with your line of business.
Don’t budget a theoretical or ideal Cost of Goods Sold – use a COGS that is based on the real numbers that franchisees in your area are experiencing. If you are the first franchisee in your area, be sure to verify distribution costs, which sometimes vary widely from market to market.
Verify labor costs. Just because someone in one city pays $8/hour for help doesn’t mean that you will also. It could be more, or it could be less.
Verify real estate costs. If you need to rent or purchase space, make sure you understand what other franchisees in your market are paying.
After you sign your franchise agreement:
Prepare a detailed proforma. Be sure to include projections for startup and for ongoing operations. If you’ve established a relationship with any franchisees, ask them for help again. Many will be amazingly open with their books, partly because they’re nice, and partly because it’s in their best interest to see you succeed.
Be realistic about startup costs, operating costs, and revenue. Don’t base your budget on “I think I can”. Base your budget on “this is what other franchisees are reporting”. Many people prepare aggressive, realistic, and conservative models so they can be as prepared as possible for whatever comes up.
Don’t guess. If you’re not sure, find out.
Factor in the cost of delays. Delays are a fact of life, even with the best planning. Make sure you have enough time and money set aside to weather whatever comes up.
If your business involves renting space, negotiate for rent abatement and TI money. First-time renters will often fail to negotiate for rent abatement (essentially, “free rent”) and Tenant Improvement money (money the landlord gives you to help make the improvements to your space). Don’t make that mistake. In fact, get an attorney to help you negotiate your lease.
Factor in turnover and training costs. People often forget to budget this expense. Remember, somebody has to pay for your employees to learn how to do their job!
Budget marketing dollars and operating capital. Even the best businesses often start slowly. Make sure you have enough money to operate the business AND market the business during that slow period. A safe bet is to have at least a year of operating capital.
Have your accountant review your detailed proforma. Your accountant’s job is to give your numbers a logical, unemotional analysis. Encourage them to challenge your assumptions on the front end, and things will end up much nicer for you on the back end.

Start with these items and you’ll be well on the road to making sure you have enough money to get to the starting line AND the finish line!

To view additional articles on franchise opportunities and compare profiles of more than 1,800 franchises for sale, please visit www.FranchiseGenius.com

This publication is copyright 2008 by Franchise Genius LLC. This copyright notice and any embedded links within this publication must remain as part of this document.

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