Franchise Terminology
When researching a Franchise you will hear all types of terms & acronyms. Just like many industries, the Franchise Industry has a few terms that are unique.
Since the word Franchise is used in many of these terms I like to make sure that everyone is familiar with them when they are researching a Franchise business.
Franchise Disclosure Document: Often known as the FDD, is an extensive 23 part legal document which is presented to potential buyers of franchises. Until July of 2007 it was originally known as the Uniform Franchise Offering Circular (UFOC).
Franchisor: A Franchisor is the company that sells the Franchise to a buyer. Often known as the “Home Office” or “Parent Office” they are the person or persons that created the franchise system. Also known as a Franchiser.
Franchisee: This is the person or group of persons that buy the Franchise from the Franchisor. The Franchisee is the owner of the local unit or location. The Franchisee typically pays a Franchise Fee to the Franchisor for the right to operate the Franchise, up front training support and a protected territory.
Franchise Agreement: This legal contract is the agreement that is signed between a Franchisee and a Franchisor. It outlines the legal terms of the Franchise. There are often references to specific payment requirements, ongoing requirements and renewal terms.
Franchise Fee: This payment is made by the Franchisee to the Franchisor. It is usually a one time up front payment that is made after the Due Diligence process is completed and the Franchisee is approved for the Franchise. This fee typically includes a protected territory as well as training and assistance on setting up the Franchise.
Due Diligence Process: When researching a Franchise this is the process a candidate goes through to learn about the company. Typically this consists of talking with the Franchisor, completing an application, attending a webinar, reviewing the Franchise Disclosure Documents, talking to an attorney, talking with existing Franchisees, visiting the Home Office and finally making a decision.
The Due Diligence process timeline varies depending on each person, typically it ranges from 4-6 weeks.
Franchise Royalty: This is an ongoing payment that is paid by the Franchisee to the Franchisor, typically this is a percentage of gross revenue. This fee pays for the ongoing assistance, training & support from the Franchisor to the Franchisee. This fee will typically range from 1% to 10% and is paid weekly or monthly in most cases.
Liquid Capital/Initial Investment: This is the amount of money a potential Franchise buyer needs to have available to them prior to any financing. Typically this needs to be around 30% of the Total Investment. For example, if the Total Investment for a Franchise is $100k then the Initial Investment would be 30% of that or roughly $33k. This number is actually determined by the Bank that would provide the Franchise Financing and is often based on your Net Worth, previous experience, Total Investment and your credit rating/report.
Net Worth: Banks often look at a Franchise buyers Net Worth when approving them for Franchise Financing. An individual’s Net Worth is calculated by subtracting everything you owe from everything you own. For example, if you owe $100k and you own $250k worth of property, investments, real estate etc…then your Net Worth would be $150k.
Total Investment: This is the total amount someone would invest into a Franchise to open the business. This would include examples like: signs, working capital, Franchise Fee, deposits, basically everything that would be needed to open the business.
Typically the FDD provides a range on what the average Total Investment is for a Franchise based on the past experience of their Franchisees.
Franchise Financing: This type of financing is secured after a Franchise buyer has paid the Franchisor the Franchise Fee. Typically banks require good credit, some net worth and roughly 30% of the Total Investment down in order to qualify for Franchise Financing.
SBA Guaranteed Loans: These loans available for some Franchise buyers for some Franchises depending on qualifications and availability. The SBA does not actually offer Franchise Loans, they guarantee the loan from a conventional bank. A Franchise buyer must apply at a regular bank that handles SBA Guaranteed Loans in order to go through the process.
The SBA does not offer Grants for starting a business, this is a common myth.
Working Capital: This is the amount of money a Franchise buyer needs to have in the bank after all of the initial investments are made to open the business. This number is usually included in the Total Investment. This is the money that a new Franchisee would use to pay the bills while the business is ramping up.
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