The Six Financial Terms Every Franchisee Needs to Know
Much of the becoming-a-franchisee process involves face-to-face interaction and networking. This could include talking to a franchisor; hearing what other franchisees have to say; or being grilled by a potential lender. The last conversation, one of great importance, is more likely to succeed if you have done your homework and are able to use the correct franchise terminology. Mumbling "Err, wait a second!" and whipping out a dictionary never impresses a banker.
We're half way through Ten to One, and this month's list explains the meaning of six financial terms used in the franchise industry:
1. Advertising Levy/Advertising Fee
This payment is made by all franchisees, usually on a monthly basis. It is calculated as a certain percentage of the franchisee's total revenue, typically ranging from 0.5% to 5%. The idea is that when the small contributions are pooled, there will be money available to spend on expensive types of advertising such as TV and radio. This is something all franchisees will benefit from.
This is the wealth that a potential franchisee needs, and it comes in a few forms.
- Human capital: the knowledge, experience and skills the franchisee will bring to the franchise.
- Financial capital: required to pay for the initial investment (see below) and licensing fee.
- Working capital: the amount wanted to keep the franchise in operation until it becomes profitable. Costs could include salaries, legal charges, and the franchisee's own living expenses.
Collateral are resources, belongings, or other assets of wealth and value that a borrower may offer a lender to guarantee the loan or credit that is being given. If the borrower fails to pay back the loan, the lender may seize the collateral and sell it. A business can use its inventory as collateral, including all its stocks, merchandise, equipment, and bonds. A borrower can also secure a loan by using another person as an endorser of the contract. That person signs a note promising to back up the obligations of the borrower. If the borrower defaults, the endorser is liable for the contract, and must pay the funds to the lender.
4. Earnings Claims
These are the sales/profits that a franchisor states a franchisee can expect to make. It is important for a potential franchisee to obtain these figures in writing before entering into any contract. One way to find out how credible the earnings claims are is to ask current or past franchisees of the network if their experiences match the predictions.
5. Initial Investment and Initial Fee
The initial investment is the financial capital required to get the franchise up and running. It involves costs such as property, stock, equipment, and the initial fee. The initial fee is paid by the franchisee to the franchisor when the franchise agreement is signed. Unlike the royalty fees, which are ongoing, it is a lump sum. It covers training, the right to use the franchise brand name, setting up the territory, and the launch of the unit. Generally, the more well-known the franchise is, the higher the initial fee is going to be.
6. Royalty Fees
These are the monthly charges that the franchisee pays to the franchisor in order to stay within the franchise network. In return the franchisee will benefit from support such as training programmes and accounting systems, plus they will keep the right to operate using the franchise's business model and trademarks. The fees are calculated based on the franchisee's gross sales for the month, and range from 3% to 20%. In some cases royalties are a flat amount every month, regardless of the franchisee's sales.