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How much money should I put aside to fund my franchise's early growth?
How much should I put aside to finance my franchise during its 'growth phase?' How far ahead should I plan?
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4 Answers
Hi Chris:
Interesting question. Obviously, you're either thinking about starting a franchise or are in the process of securing one. Congratulations. Our economy needs more investment right now and your timing may end up being particularly good as consumers gain more confidence. Generally, franchising is a spectacular way to grow any business, particularly consumer-oriented sales businesses like food service, auto maintenance, financial services. It always takes franchisees with their eyes wide open to really do it well. The biggest reason franchisees fail is that they didn't read the contracts well enough.
Get more information from your franchisor and from your peer franchisees. The biggest thing you can do is to ask your franchisor this question and many more, and ask any franchisee you've been introduced to, and a few franchisees that you stumble across.
No doubt, the real answer depends a great deal on the product or service market you're entering. For example, if this is a car dealership, you will need have plenty of cash ready to fund the first year (or two) of operations because you're going to have several months of operations where the service bay, sales staff and customers end up figuring out how to and if they want to do business with you. If on the other hand, this is a dog grooming or hot dog vending operation, your monthly routine expenses (lease, taxes, heating/cooling, insurance, labor, supplies) will be lower, and so the number of customers to get to positive cashflow will be shorter than the car business.
Even when you get to positive cashflow, you will probably need to continue to somewhat over-invest in marketing your business to sustain your position and keep earning new customers. I think this recession has really taught a lot of business people to have a healthy cushion of cash on hand so they can ride out rough spots like the last 2 years.
So, depending on the type of franchise you're planning, I would think that it would be prudent to have as much cash on hand as 3-6 months of zero revenues. Of course, as a fiscally conscious manager, you'd turn down the variable elements of costs in a slow period (fewer labor hours, less overtime etc) to keep costs in line with revenues, but then at some point you'd re-invest to move the business forward as demand returned.
Hey Chris,
Peter makes some great points here. I'm pretty sure most franchisers have decent metrics on this that they can provide to you, and if they don't, I would take a serious look at why not. Still, those are only a general guideline, and your results will be different as the curveballs that life will throw at you over time can have a huge effect. From a financial perspective, I would start with a realistic expense projection, take that number and double it as that is more likely what you will incur (things always, always cost more than originally expected...), and then take that number and double again to estimate the cash you will need. This is rather conservative, but you need to give yourself a chance to succeed, and the more runway the better, as many businesses fail right before they get to success because they just ran out of cash. That said, you still need to treat every dollar you spend like it is your last one, while not being afraid to be creative and explore ways to differentiate your service/product. Spend, but do so wisely...;)
I also add my congrats to Peter's, and wish you success in your new business.
Bob
All very good points and I would tag onto one of Bob's comments in particular. In my opinion, it is critical that you put together a good set of forecasts, one that can give you key metrics, such as break even levels and minimum cash requirements. It is a good principle to have 3-6 months of expense reserves on hand, as Peter suggested, but some of the expenses you are going to incur are variable, ie they will fluctuate directly or closely with sales. You need to be able to identify what is fixed and what is variable in order to plan properly. I will leave you with a couple of thoughts to reinforce what I am saying, the first being that wise businessmen will always hope for the best, but plan for the worst. The second is that you need to know that you will have access to the right level of resources to fully capitalize on demand. There is nothing more soul destroying than watching the big opportunity pass you by because you didn't have the resources to maximize your advantage. Good luck with your new endeavor. If I can be of any help, please don't hesitate to get in touch.
Chris, I concur with much that is being said here.
The amount of money will be directly dependent on your specifics. I suggest you start with building a "bottoms up" budget. Identify all possible costs that you think or plan on incurring. Since you are, or will be starting, your costs should be directed primarily at growing revenue as rapidly as possible, so most of your costs should be devoted to marketing and sales.
Once you have your budget, add 20-40% as a contingency for what inevitably will be unexpected and unanticipated expenses, or opportunities.
As stated by by Geoffrey, create a monthly forecast for the first year, then quarterly for the next year. I agree with Geoffrey that you should have reserves. I differ in that you should think longer term. I counsel clients that they should have, or can obtain a minimum of 9 months operating expenses for several reasons.
First, your growth will probably occur more slowly than you had planned, or as evenly as you expect.
Two, keeping anything less creates an extremely short term focus that will have a significant impact on your decision making. If you are constantly worried about running out of money in 3-6 months, your focus will be very short term and on raising additional money and not on growing the business.
Your franchiser, or fellow franchisees, can provide value input on your budget and operating cash requirements.
Before you pull the lever and spend a dime, know your costs, create your cash forecast, plan for the unexpected, plan for cash resources that take you out a minimum of 9 months. Every minute and dollar you spend on planning, will save you 10 down the road.
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