Franchising is a popular business model that allows one to grow and expand a business strategically by letting people run a brand in different locations.
Since it gives a great opportunity to expand a business for the owners and a sizeable income for the franchisee, it is getting increasingly popular daily.
However, establishing a franchise is not a piece of cake as many requirements exist.
Among these many requirements, there are quite a lot of terms going around which could be confusing.
One of the most confusing terms, especially in franchise finances, is “liquid capital.” Some people see this as the money you need to buy a franchise, but that is not the case. It’s way deeper.
What Is Liquid Capital In Franchise?
When you sign your franchise agreement, your agreement will have the definition of liquid capital on your agreement.
The definition might change, but in almost all cases, it is the same. Most franchisors define liquid capital as the cash you currently have to enter into a franchise agreement.
This means you must hold a certain amount of cash to agree, not buy a franchise.
The reason there is a liquid capital requirement to agree is to make sure that you have your cash and that you can use it when you need it or when the time is right.
It also ensures you are not borrowing from anyone to use at the right time and that it’s all your money.
Also Read: What Is Initial Investment In Franchise?
Why Liquid Capital Is Important?
The whole point of liquid capital is to ensure that in case of something goes wrong, you can use that liquid capital to save the franchise. If a franchise branch has to shut down, this negatively affects the franchisor.
There has to be protected. Some of the problems you could face and where you have to use your liquid capital are:
- Overdue bills,
- Late rent payments,
- Sales are not enough to cover the expenses of the branch,
- Any other problem that requires you to come up with cash when revenue is not enough to cover.
Without this liquid capital to spend at any wrong time, the branch would have to shut down, and every investment would be for nothing.
That is why franchisors openly describe liquid capital and expect a certain liquid capital level. A franchisee must be ready to cover any amount specified in the agreement.
Liquid Capital vs. Net Worth
While preparing the franchise agreement and going through the terms, most terms people get confused about are liquid capital and net worth.
The confusion mostly comes from the idea that both are the same and there aren’t any differences. However, the two terms are very different, and they both serve different purposes.
Shortly, liquid capital is the cash at hand that is not tied to anything, and you can spend it anytime you need it.
Net worth basically covers everything you own, from your cash and your assets to your liabilities, and calculates the worth of the branch or you. This means that net worth is your total assets minus total liabilities.
Net worth is not cash. Most people confuse net worth with the cash you have at hand, but net worth never gives you the current cash you have.
It doesn’t actually refer to anything that you can spend right away, and you can’t even liquidate your assets at that price most of the time.
It is solely a number that you calculate by your current entire financial situation. Whereas you can spend your liquid capital at any given moment and your cash at hand is the money you have.
How Much Liquid Capital Do You Need?
The tricky part about liquid capital is that any franchisor could ask for different numbers for a franchisee to have.
There is no set limit by law or practice; it all depends on the franchisor and the business or industry you are in.
Some industries require immense amounts of money in cash, or it might take a while to generate revenue, so you need high liquid capital.
Here are some of the industries that require high liquid capital:
- Hotel chains
- Gas stations
- Energy companies
- Technology companies
At the minimum, a liquid capital requirement could be around $50,000-$60,000 for most of the agreements, and it could go as high as $500,000.
There is no way to know this number before talking to the franchisor and seeing their requirements.
These numbers generally come from used practices and experiences of the franchisor, so you can make sure that you will definitely need that amount of liquid capital.
Franchising is a great method to expand a business and grow at a faster rate than any other option for a business.
It also allows the franchisee to get a business that is already ready with everything and gets customers from day one.
Yet, there are many requirements you need to obey when running a franchise as a franchisee.
Liquid capital is one of the first requirements. It is the cash you need to sign the agreement for the franchise.
This cash you have shouldn’t be confused with other financial metrics, such as net worth, which calculates everything you own.
The minimum liquid capital requirement changes from franchise to franchise, and there is no set number.
Amit Gupta is the founder of DrFranchises – a digital marketing agency that helps brands rank better on Google Maps through local SEO strategies. Amit has over 11 years of experience in digital marketing, SEO, email marketing, and social media marketing. He’s also the owner of multiple franchises and has helped countless brands achieve success online. When he’s not working, Amit can be found playing with his dog.