The Importance of Determining the Amount of Reserve Capital Necessary to Buy a Franchise
Although this blog post will be short‚ the topic is of critical importance to both franchisors and franchisees. The topic is "reserve capital"‚ that is‚ how much in savings should a new franchisee possess establishing a new franchise location. Without reserve capital (funds in a bank account after the grand opening of the franchised business) franchisees may face unnecessary business failure which‚ in turn‚ causes a degree of failure for the franchisor – a closed franchise location.
Time and again‚ I have seen that one of the largest reasons for franchisee failure is insufficient reserve funds. Without these funds‚ the pressure is on starting on day one and with the added financial pressure comes‚ many times‚ a franchisees failure to reinvest revenue into the continued marketing and development of the new franchised business.
Points to Consider When Determining Reserve Capital Amount
Here are some general thoughts:
- Reserve capital requirements will absolutely vary based on the nature of the franchised business‚ i.e.‚ does the business involves the sale of "services" which may require a longer development period or the retail sale of "goods" which may have more immediate sales but‚ typically‚ higher operating expenses?
- Reserve capital requirements will vary based on the individual circumstances of the franchisee‚ i.e.‚ does the franchisee have a spouse who will earn a salary from a separate job or business?
- No business is profitable on day 1‚ week 1‚ month 1 or‚ quite frankly month 6 and if you think that you are‚ you are probably not as you‚ most likely‚ will be diverting capital / revenues / perceived profits to pay for your personal expenses when they should be reinvested in your business.
Consider FDD Item 7
If you are buying a franchise‚ consider that FDD "Item 7" ("Your Estimated Initial Investment") will include an estimate of "Additional Funds" / reserve capital that you should include in your estimated overall investment. Give serious consideration to this estimate and‚ if it were me‚ I would assume that my start-up reserve capital should be equal to no less than 6 months of my living expenses.