Understanding the Cost of Buying a Franchise
Advice from a Canadian franchise lawyer
One of the most commonly asked questions by someone who is acquiring a franchise is: how much will it cost? The answer to this question depends to a great extent on whether you are acquiring an existing franchise or the right to operate a new franchise.
The cost to acquire an existing franchise will depend on the asking price of the franchisee who is selling their business and how much the potential purchaser is prepared to pay for the franchise. The ultimate purchase price will be a matter of negotiation between the purchaser and the seller of the franchise.
In addition to the actual purchase price for the franchise, a transfer fee will usually have to be paid to the franchisor for the right to sell the franchise. It is not uncommon for the transfer fee to be paid by the purchaser or included as part of the purchase price for the franchise. The transfer fee is either a set monetary amount or a percentage of the amount that the franchisor then charges to new franchisees as an initial fee. Franchisors charge transfer fees in order to off-set the costs of reviewing and considering the potential purchaser, training the purchaser to become a franchisee and other administrative costs franchisors normally incur in relation to a transfer of a franchise.
The franchisor's most significant involvement in the sale of an existing franchise is deciding whether it will approve the purchaser to become one of the franchisor's franchisees. Almost all franchisors reserve the right to approve any transfer of a franchise and the franchisor's approval is typically subject to a number of factors such as:
- the purchaser agreeing to execute the franchisor's then current form of franchise agreement or a form of assignment of the current franchise agreement.
- the purchaser satisfying the franchisor that it has the financial, business and operational capability to operate the franchise.
- if the franchise operates from leased premises, evidence that the landlord will consent to the proposed sale.
- the purchaser completing the franchisor's current training program.
- the purchaser satisfying the franchisor that it is not in any way involved in a business that is competitive to the business which is operated by the franchisor.
In some circumstances a franchisee will also be required to obtain the franchisor's prior approval to the price at which the franchise is being sold. Some franchisors want to approve the sale price of a franchise because they do not want a franchise being sold for so high a price that will effect the incoming franchisee's ability to successfully operate the franchise.
When someone acquires the right to operate a new franchise, the cost of acquisition is less a matter of negotiation and more a matter of how much the franchisor will charge for the right to operate the franchise. In addition, the franchisee will also have to acquire all of the necessary equipment, fixtures and premises to be able to operate the franchise. Some franchisors in Canada offer franchisees what are known as "turn-key franchises". In the case of a "turn-key franchise", the franchisee is charged one set amount to acquire the rights to operate the franchise and all of the assets needed to begin operation of the franchise. For example, the set amount to acquire a turn-key fast food franchise usually includes the initial fee payable to the franchisor and the cost to acquire all assets needed to operate the franchise, which would include kitchen equipment, furniture and an initial inventory, as well as the cost to build the physical premises from which the franchise is to operate.
Franchisors who do not offer turn-key franchises simply charge an initial fee to the franchisee for the right to operate a franchise and require the franchisee to acquire the assets necessary to operate the franchise. The amount of the initial fee varies quite widely but is commonly in the range of $25,000 to $50,000 for a single unit. However, this fee simply gives the franchisee the right to operate a franchise and does not provide the franchisee with any of the assets that are required to actually open for business. In this scenario, the franchisee is the one who will acquire and pay for all of the assets needed to operate the franchise. In determining the potential costs of acquiring a franchise on this model, a franchisee needs to carefully consider all of the various items of cost that will need to be incurred in order to open for business. Many franchisees create a detailed budget with the assistance of the franchisor in order to determine a range of estimated costs to set up the franchise.
Whether someone is acquiring an existing franchise or a new franchise, the question of how much it will cost is an important one that needs to be considered carefully by the prospective franchisee. A franchisee who pays too much for a franchise will in many cases struggle financially or obtain a return on investment that is not particularly attractive. A prospective franchisee has a much better chance of obtaining a good return on their investment by carefully considering all the costs associated with acquiring a franchise prior to making any investment decisions.
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