Visit the dairy counter of any supermarket and what do you see? Gallons of milk, cartons of yogurt, cheese, etc. Each carries a clearly marked price tag: $1.99, $0.75, and so on. What you don’t see are the extra costs that show up when you check out at the register. Extra costs like sales tax, or, paper/plastic back fees charged in states requiring shoppers to bring their own grocery bags.
Cost plus
Buying a franchise is kind of like that. But the good news is when you purchase a franchise, the franchise fee and nearly all of the additional costs are disclosed. The following outlines what you need to know and where to find it:
Read the FDD
Before you can buy a franchise, the franchisor must provide you with a franchise disclosure document (“FDD”). The FDD spells out 23 important data points and includes a copy of the franchise agreement that you will sign if you decide to proceed. Data points include the following information on the cost to buy and open the franchise:
- Item 5 indicates your “initial franchise fee,” as well as any other fees you will be required to pay your franchisor before you open for business;
- Item 6 details the “royalty” and other ongoing fees that you may have to pay while operating your franchise; and
- The chart in Item 7 provides you with an idea of your start-up costs, which include your initial investment costs to build out your franchise and certain additional funds that you may need before your business starts generating a profit.
Covering franchisor costs
If you are buying a single unit franchise, your franchisor likely will charge you an “initial franchise fee.” Initial franchise fees typically range from $10,000-$15,000 for a home-based franchise to $75,000-$85,000 for a brick and mortar franchise. Important note: Check to see if your initial franchise fee is refundable in the event the deal falls through and you do not open the franchise.
Where does that fee go?
Initial franchise fees go to the franchisor. They are intended to cover the costs associated with approving you as a franchisee, to pay for your initial training, and maybe even site selection costs. The fee also may be used to reimburse the franchisor for opportunity losses as it no longer is going to market the territory you are considering once you are assigned it.
Item 7 of the FDD contains a chart that is intended to be an estimate of your start-up costs. It covers costs incurred before you open for business as well as costs you will incur over a reasonable period (usually at least three months) once you begin operations.
This chart outlines expenses, including those relating to equipment costs, rent and lease improvements, and initial inventory. While it is only a starting point, you will want to look at Item 7 carefully to ensure you clearly understand what types of expenses you will incur in launching your franchise. And, make sure you also conduct your own due diligence on potential costs.
The devil is always in the details
As we always tell clients, the devil is in every franchise agreement’s details — whether you are thinking of buying a franchise or selling a franchise or other privately-held business or practice. Most issues can be addressed fairly early in the franchise/business selling/buying process, but only if you know those exposures exist. Protect yourself whether you are a buyer or seller. Consider retaining experienced franchise counsel to guide you through the franchise acquisition/disposition process. Still, have questions? Contact me.
