The initial investment
The disclosure document must also contain information about what the franchisee will need to spend as an initial investment in his/her franchise. In most cases, this information will also be displayed in a chart, outlining specific expenditures that will need to be made as the franchise gets up and running.
As these expenses can vary, the chart will usually specify a low-to-high range for each type. It is then important for the prospective franchisee to determine the most likely scenario for his/her own proposed location. Amounts can vary substantially, depending on the region, the size of the premises, local economic conditions and other factors.
These expenses are also estimates that, generally, do not take into account any financing charges or other related costs, such as calculating the Goods and Services Tax (GST) at the federal level or the Provincial Sales Tax (PST) or Harmonized Sales Tax (HST) at a provincial level. Indeed, the franchisor will qualify its initial investment statements by describing them as “estimates only.”
The initial investment will cover off some of the same items listed previously, including the franchise fee and insurance, but will also include a number of other one-time payments as required during the startup phase. These will include the following costs:
- Leasehold improvements.
- Furniture and decor.
- Lease and utility security deposits.
- Computer equipment.
- Professional fees, i.e. for lawyers, accountants, etc.
- Startup supplies.
- Grand opening promotions.
The disclosure document will also often include an initial estimate of the working capital the new franchisee will require going forward. Again, this is only an estimate, so it is extremely important to review all of the items with a financial advisor and develop a business plan specific to the individual franchise, taking into account the actual costs associated with the location. Some U.S.-based and other international franchisors have little experience in Canada, for example, and it will not be sufficient to rely upon their information from foreign jurisdictions. Accurate estimates may be more difficult to ascertain until they have gained more experience in the Canadian market.
Also, while franchisors may seek to provide as accurate expenditure information as possible, they can also be expected to be very conservative when calculating their estimates.
Working capital and annual operating costs
Franchisors are not legally required to provide estimates of working capital or annual operating costs, though some will do so anyway. In cases where the information is not provided, the disclosure document will contain a specific statement to this effect: ‘Estimates of working capital and annual operating costs are not provided by the franchisor.’
In cases where the information is provided, most franchisors will state additional funds are required to finance a franchise’s operations until the business generates positive cash flow. They will often quantify how much capital could be required over the initial three-month, six-month and/or one-year period.
As for annual operating costs, most franchisors do not provide this information and prospective franchisees should not expect to receive it. There is a concern franchisees may rely on such figures, treating them as an exact representation of operating costs, when in fact such costs can vary substantially, due to a variety of factors, including those mentioned above. Franchisors do not want to foster unrealistic expectations, as these could lead to a risk of legal liability for ‘misrepresenting’ the costs of operating a franchise over time. (Note that annual operating costs are different from financial performance representations, which will be covered in a future article.)
That said, there have been rare instances where franchisors included information about annual operating costs in their disclosure documents. In such cases, this information should still be reviewed carefully with a financial advisor, so the data can be customized for the franchisee’s unique circumstances.