What Is Initial Investment In Franchise?

Franchises are one of the most popular ways of owning your own business. They are not as risky as creating a new business from scratch with no market value and branding.

They can be easier to generate sizeable income. You take on an already established brand’s name and run that by the rules of that brand.

Because there isn’t much work involved in setting up and running a franchise, it is extremely beneficial.

However, the start-up costs are always higher than creating your own business because franchises require a certain amount of investment to start off.

One of the things you have to consider is the initial investment, meaning how much you need to invest in starting, which is known as the initial investment.

What Is Initial Investment In Franchise?
What Is Initial Investment In Franchise?

What Is Initial Investment In Franchise?

The initial investment is officially the seventh item within the Franchise Disclosure Document (FDD) that you need to sign when you start a franchise.

This initial investment you need to make on FDD is mandated by federal and state law, where the franchisor has to disclose an estimate of all the start-up costs.

All the costs expressed in item 7 are officially the initial investment you need to start the franchise.

All the costs on item seven will mostly come from the franchisor’s experience and use the previously established franchises’ cost to come up with a number.

If that’s not the case, then the franchisee’s experience might count in when setting up the number.

Once this number is set, you can expect to spend exactly that amount unless there is an unforeseen event.

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What Is Included In the Initial Investment?

When it comes to setting up that estimated number within the initial investment, the franchisor considers several things.

By law, there are seven categories the franchisor must include in the initial investment.

The seven categories you have to calculate vary significantly by location, the franchise’s own costs, inventory, and so on.

  • Initial Franchise Fee

An initial franchise fee is a number that the franchisor sets for people who want to franchise their business. This number is an initial fee, and you pay it upfront, and it is generally recurring.

However, the recurring fee might be in a different shape than the initial franchise fee and might take two ways:

  1. Lump-sum 
  2. Commission.

Mostly the franchisor will already have a set way of a continuous franchise fee, but their initial franchise fee will be fixed.

In the lump-sum method, you pay a set fee to the franchisor annually, bi-annually, monthly, or on another schedule you agree on.

With commission, you pay a certain percentage per every sale the franchise makes, but the starting fee you pay to the franchise is lower in this case.

  • Training Expenses

With franchises, there are set rules and ways of working to establish a certain quality on all the branches of the brand.

To make sure that everything works the same everywhere, the staff needs to take a training. This training also comes with its expense.

The cost of the training and other associated costs to the training comes from the franchisor and its training methods.

However, the franchisee can also look at other training expenses within the franchise to get an idea of how much it should cost.

The whole of the expenses for the training depends on the number of employees, what pieces of training they need, and other details.

  • Property Costs (Lease or Rent)

The property where the franchise will start working could belong to the franchisee, or the franchisee will lease the building.

The franchisor has the option to decline the building and not give the rights to the franchise if they deem it’s not good enough.

However, considering that it’s accepted, all the costs associated with the property falls under the initial investment, and the franchisee have to cover it.

  • All The Equipment, Including Construction, Decoration, Fixtures

In addition to the training of the employees, the building, decoration, and every other detail within the building must also follow the brand’s rules.

So, this means that there has to be some equipment to buy for the franchise when starting off. All this equipment will come from the franchisor itself.

However, the prices of the equipment will belong to the franchisee because the type of equipment, decoration, fixture, and other details will depend on the location. That is why the franchisee must pay for all the equipment associated with the brand.

  • Starting Inventory

To establish quality, the franchisor makes agreements with local producers to make sure that all the branches get quality inventory.

The good part about providing inventory is that you don’t have to deal with finding a quality provider for all your inventory. However, the costs of the inventory will again fall under the wings of the franchisee.

Under the initial investment, you will need to have a certain starting inventory to get things going.

Determining this will be up to both franchisee and franchisor to make sure to get the right amount of inventory.

  • Pre-Paid Expenses Such as Business Licenses, Deposits

It doesn’t matter if you obey the rules of a business and follow the quality standards that are already accepted with a license.

You still need to get the necessary permits to start the business. These fall under pre-paid expenses, which you must pay in advance before running the franchise.

Anything that you have to pay before starting the business falls under pre-paid expenses.

All these depend on the state you are in, the deposits you have to pay for the property and other stuff, and other necessary things.

The franchisor will provide you with an expense list, but there might be some special permits you need to get if you are in a different state.

  • Additional Funds

You will also need additional funds to cover any unexpected spending and the working capital to get the business going in the first few months.

These are under the additional funds category, and your franchisor will give you an estimation.

Read: What Are Royalty Fees In Franchise?


The Verdict

Franchises are growing in popularity nowadays because it’s less risky and provides you with an already-established brand.

However, franchises also come with their cost even from day one, which is known as the initial investment.

This initial investment and its estimation will be on your Franchise Disclosure Document (FDD) in item seven.

The initial investment includes seven categories, and they are mandated by both federal and state laws, where the franchisor has to give you an estimation. 


Source

https://www.franchiselawsolutions.com/learn/buy-a-franchise/what-is-the-initial-investment-item-7-in-the-franchise-disclosure-document

https://lusthausfranchiselaw.com/blog/how-do-you-determine-the-initial-investment-for-the-fdd/

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