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Perhaps the most essential building block to starting a new business is sufficient capitalization. So what are the best ways to ensure you have enough money to start and run your business until you begin to earn a profit?

Preparation must come first, so by the time you sink any money into your new business, you will have completed your due diligence and set a solid path to success. This includes extensive research into your future business, including interviewing many people along the way to help you settle on a business that best matches your skills, experience and interest.

If, like many budding new business-owners you select a franchise, you will have consulted a franchise coach, an accountant, plus the many experts with the franchise company, trained to help you start a successful business.

Since many franchises are purchased by people who have never owned their own business before and may even be new to the particular industry, traditional bank lending may not be a viable option. The good news is that many other financing options are available to finance your new business.

Most franchisees put together a package that may include:

• A loan from the U.S. Small Business Association (SBA)
• Traditional savings
• Home equity loan, or
• Increasingly common, rollover of a 401K or IRA.

While using retirement funds to help you start a new business should not be undertaken lightly, this procedure has many advantages, according to Sherri Seiber, chief operating officer of FranFund Inc., a Fort Worth-Tex.-based firm that has advised thousands of franchisees on funding their new businesses.

The use of a retirement fund rollover allows you to self-fund your new business and save the costs associated with a loan. Demand for loans, at its highest level since the Great Recession, still exceeds supply, according to an article in the June Franchising World magazine.

“This rollover program is the No. 1 way businesses under $150,000 to $200,000 are getting funded,”Seiber said. “Sixty-five to 70 percent of our clients use this (method) alone or in conjunction with a loan.”

Some people use a rollover as a way to inject equity into a loan application.
The main caveat is that you could lose your retirement savings, and as Seiber notes, if you don’t believe you can be successful in your new business, this path is probably not for you —and, of course, you may not want to go into that business at all.

Seiber said the Employee Retirement Income Security Act of 1974, allows people to roll over a portion or all of their 401K or IRA (not a Roth IRA) into a new 401K profit-sharing plan sponsored by your new corporation, which buys stock in the new corporation without penalty or paying additional tax.

So the 401K becomes a stockholder in the new business. The operating account of this new corporation can be used for any legitimate business expense, including paying yourself a salary during the start-up phase before you begin generating revenue.

Seiber noted that most of her clients do very well funding their franchises this way. FranFund has only a 3 percent to 4 percent annual attrition rate, but not all these are failures, she said. Of course, most of FranFund’s business comes from referrals, and most of her clients have completed extensive due diligence beforehand.

The final question you have to ask yourself is if you really believe you have what it takes, meaning skills, experience and work ethic, to make a success of your new business. If the answer is a resounding yes, then why not invest in yourself?

So you’ve selected a franchise and have your initial investment capital saved and now you want to know: How much money will I make? To answer the question you’ll need to weigh your costs against expected potential revenues.

The beauty of a franchise is you actually have a good shot at figuring all these numbers out. Between the financial disclosure document (FDD) and information available from existing franchisees, you can get a good feel for expenses, as well as potential revenues, so long as you factor in differences related to location, local market and, not to be forgotten, the range of talents and experience individual franchisees bring to their businesses.

Why is it so important to do this math upfront? In a phrase, operating capital.

Lots of folks eager to become entrepreneurs for all the usual reasons -to control your own schedule, achieve work-life balance, be your own boss, and make more money -may neglect to factor in all the capital requirements.

At the beginning of a new business comes the transitional stage. This means you need money to run your business until you learn your way around a new market, new procedures and customer care. During this transition, you won’t generate enough revenue to cover expenses. So it’s essential you have enough capital to keep the circuits humming.

Your first task is to get a realistic sense of how much capital you need to get started. Fortunately, the FDD will provide this view of your costs. Some companies will even provide an idea of potential earnings. A franchise coach can help guide you through the process, but it’s never too early to start your research.

Three Keys to Understanding Your Potential Earnings

Know your Timetable

Most businesses take three to 12 months to start earning profits. The slowest to become profitable are franchises with a lot of costs or ones that take longer to build a customer base. And if the margins are thinner, you need to generate more volume. For example, a document shredding franchise, which requires expensive equipment, may take as long as 18 months to run in the black but can eventually become quite lucrative. Retail franchises can be among the quickest to turn a profit because a good location will quickly draw customers.

Accurately Estimate Your Fixed Costs

The franchise disclosure document provides a list of all your costs -everything you need to open -which are far more extensive than just the initial franchise fee. Examples of the types of fees you’ll find under Items 5 and 6 in the FDD are: IT and system setup and initial marketing. Then comes ongoing fees, such as local marketing additional training, ongoing IT or software costs, costs for audits, insurance, and on and on. In short, all of the costs you would expect to encounter.

In your calculations, you should also factor in the cost of consulting an attorney and accountant, which we strongly recommend.

Estimate Potential Income

Flip now to Item 19 of the FDD to read if the franchisor has made any earnings claims. Only about one-third of franchisors make earnings claims, and how franchise companies address this issue varies.

To fill out the picture, your most important information can be found in Item 20, where you’ll find a list of franchisees. You want to call as many franchisees as possible, preferably those operating in locations similar to yours, to verify all the information in the FDD and get an idea on profits. Word to the wise, avoid the question: “How much money do you earn?” Instead, try a softer approach, such as: “How long until I can expect to make $100,000.” Then try out different income amounts.

All three steps are essential to your preparation. Doing the due diligence required to choose the right franchise upfront will help you experience the pleasure of being your own boss for years to come.

Want to Buy a Franchise: Learn To Navigate the 23 Steps to Success

Twenty-three? That’s the number of items in the Franchise Disclosure Document -your golden ticket that franchise companies are required to provide their prospective franchisees.

The disclosure rules enforced by the Federal Trade Commission (FTC) give you the tools you need to choose a franchise. Once you learn to navigate this comprehensive document, you should be able to make a match that will allow you to succeed in your new business.

The trick is to figure out where to focus your energy. A franchise coach can help you understand the fine print. But as you begin to peruse these documents, we recommend you focus on the following items:

Item 1 – The Franchisor

The very first page gives you the business history of the franchisor, where it is incorporated, other names under which it has operated and a general description of the business.

Item 3 – Litigation

You’re not looking for a gotcha moment for a single lawsuit, but if you see a history of many lawsuits brought by franchisees, heed the warning, stop reading, and cross this franchise off your list.

Item 7 – Initial Investment

Don’t blink at the numbers. Without enough start-up capital, your business will likely flounder. You need enough money to run your business for a few months. You will see a list of costs including an initial fee, costs to improve the leased space, estimated wages, lease payments, cost to purchase furniture and fixtures and a sign, architectural and engineering fees, initial investment in inventory, insurance, plus additional costs estimated by the franchisor.

Item 12 – Territory

Some franchises have what’s called a protected or exclusive territories. This is a promise that they will not allow another franchisee to operate within a specified distance of your location. Protected territories are not necessarily better, but you do want to understand the parameters.

Item 19 – Earnings Claim

Only about a third of all franchises make earnings claims. When making earnings claims, franchises are required to provide specific supporting materials, including exactly which outlets were included. Since earnings for individual franchises can vary substantially, we recommend you verify any numbers you see in this section with individual franchisees.

Item 20 – List of Franchise Outlets

Your most important section since this is where you will find the key that will help you open the door to a successful business future: the names, locations and phone numbers of all franchisees currently operating, as well as franchisees no longer operating. You should call as many as you can, both current and former franchisees, to learn about their businesses. Has the franchisor’s support systems been helpful? How long did it take for them to become profitable? Are they satisfied with the franchise? Would they purchase this franchise again? For the former franchisee, what went wrong?

Item 21 –Financial Statements

Franchisors are required to include copies of their audited financial statements for the most recent three fiscal years to demonstrate the financial condition of the company.

Hardly ever when you enter a business, do you receive such a comprehensive roadmap to help you plot your way to success. It’s up to you to use this treasure trove of information and complete your due diligence so you can make the choice that makes your career.

Buying a franchise is one of the quickest, safest ways to start your own business, but a franchise is not for everyone, particularly if you’re the type of person who likes to blaze your own trail.

For starters, to be successful with a franchise — that is to maximize your potential earnings — you must be prepared to follow the franchisor’s system, the time-tested method the company has for virtually every aspect of its operations, including staffing protocols, an advertising campaign and store build-out plans.

After working with dozens of franchisees over the years, I still see new franchisees decide they can cut corners, for example, by declining to hire enough people to cover the day-to-day responsibilities of meeting the needs of customers.

The owner may decide to save money by doing some of the work himself, for example, cleaning houses or caring for seniors. As a result the owner has less time to build the business, creating a steady and growing clientele to generate earnings. While that owner may save some upfront costs, he or she loses long-term earnings potential.

So how do you know if you are a good candidate for a franchise? Answer eight easy questions:

1.    Are you prepared to thoroughly research the business?

Selecting a franchise may be your first most important step, and the process requires solid research, from reading background materials to putting shoe leather to pavement and visiting franchisees.

2.    Are you prepared to work hard?

Just because the business comes with a system doesn’t mean you won’t have a learning curve. Of course, once you have good employees in place and operations running smoothly, many franchise operations will allow you to take an afternoon for golf or to attend a child’s track meet. Many franchisees set a realistic goal to work 30 to 35 hours per week within three to five years of starting their business.

3.    Can you call for assistance when needed?

A good franchisor wants to help you through the start-up phase, so to take full advantage of what you’re paying for, you need to be willing to ask for guidance. A good franchisor will likely offer many good suggestions, possibly a long to-do list that will require time to implement.

4.    Do you have enough capital to set up the business to operate as designed?

Before you buy the franchise, your research should have told you how long it will take to operate in the black and the Franchise Disclosure Document will tell you your upfront expenses. Getting to profitability varies by location and franchisee. You will need to be work hard and pay operating expenses for some time before earnings begin.

5.    Can you accept paying the franchisor royalties and other specified fees?

These fees are the price you pay for a proven operating system, built-in research and development, a fully vetted list of suppliers, as well as an advertising campaign and ongoing support and training.

6.    Will you accept structure in your business?

If you would rather create your own approach to a unique business that reflects your particular vision for a product line or service, you don’t want a franchise.

7.    Can you accept advice from authority?

When you buy into a franchise system, you are part of a team, and the franchisor needs each of its franchisees to present a consistent image to the buying public. No reinventing the system.

8.    And, most importantly, can you trust the system to work?

If the answer is no, then don’t buy the franchise.

Ideally, you will answer yes to each of these questions. If you answered no to more than two, then you might want to consider an independent business. I also suggest you consult a franchise coach, who is in the business to help you make the best decision to ensure success.

After all, what you want most is to have a business you enjoy in which you can excel and which will also earn a tidy profit.

Ready to make your dream of becoming an entrepreneur come true?

Get your free evaluation today!

Contact Dan Citrenbaum to create the career you’ve always wanted. As a Franchise Coach, Dan brings years of experience helping people select and buy a franchise or existing business. You can reach Dan at dcitrenbaum@gmail.com or at (484) 278-4589.

Thinking about starting your own business by buying a franchise? The good news is there are a lot of people with pertinent information to share. And, as anyone of them would tell you, good preparation is key to success.

Your best resource bar none are the company’s current and, yes, former franchisees. They offer the best information on what it’s really like to run that business, and their perspective is so valuable because they’re most likely to give it to you straight. By contrast, when you call a franchisor, you may be talking to a salesperson on commission who will tell you only what will make his company look like a great deal.

So for a more accurate picture, talk to the franchisees, the more the better. Get a list of franchisees from the franchisors, which they are required by law to provide, and call to make an appointment. Each of these franchisees has stood where you are, and most will likely be happy to help. But respect their time!

What do you need to ask franchisees? A franchise coach can help you separate the wheat from the chaff, but you will want to ask about several critical aspects of their business.

Questions for Franchisees

Personal Journey

How did you choose this franchise? Did it match your particular area of expertise? What is your business background? How long have you been in the business?

Support

Are you satisfied with the level of ongoing support from the franchisor? Face it, without support, you’re a fish out of water. Support is a huge part of what your franchise fee is supposed to pay for. Plus, if you owe ongoing royalties to the franchise company, you want to make sure you’re getting something in return for your investment.

Training

Was the training you received substantial? Was it sufficient to prepare you for running this business? Was it thorough enough for someone with no industry experience?

Preparation

Has the actual business operation matched your expectations? What challenges should a new franchisee be ready to meet?

Happiness Quotient

What do you like the most about running your business? What do you like the least? Would you do it again, knowing what you know now? Why or why not?

Profitability

How long did it take you to reach break-even? Or are you on track to reach break-even? Does the franchise have the potential to earn the franchisee a six figure income? Approximately what percentage of your gross are you earning in profits?

Business Expenses

Approximately how much per year do you spend on advertising and marketing, rent/utilities, insurance, merchandise, other?

Franchisors’ Marketing

How would you rate the franchisor’s marketing programs and tools? Does this generate a significant proportion of your business?

Management

How difficult is it to find and manage employees? How are they compensated?

The bottom line: You want to know if the franchisee’s experience seems appealing, to see if this franchise’s process would work for you. Sometimes you may learn that what hasn’t worked out for the franchisee might actually work for you since you have a different package of experiences and skills. Or you might learn that, due to some recent staff turnover, the franchisor is no longer able to provide good support systems.

You’ve got your mind set on what seems like the perfect franchise, and you’re already dreaming about your future life as a successful business owner. Sound familiar? 

Before you get out your checkbook, you need to ask yourself if you’re really prepared. Have you talked to:

•          A franchise coach

•          Franchise companies

•          Franchisees

•          An accountant

•          A franchise attorney

Sound like a lot? Not when you consider the importance of this decision, the commitment of time and money. Because once you take the leap, you and your money are on the line. There will be no one else to pick up the slack when you feel like slinking away.

First, let me say that I think a franchise is a great way to get started in business. A good franchise has already perfected the business model, plus loads of support and training for the new business owner, including technology, staffing, sales, human resources and advertising. And this is not just a one time thing. A franchisor’s staff is there to help you at every step along the way.

Choosing a franchise that is right for you is the tricky part. The answers you need require research.

Choose a Coach

A franchise coach can give you a broad window into the world of franchising, which is far larger than you likely realize. The International Franchise Association estimates that there are more than 3,000 franchises across more than 75 industries. The good news is that most franchise coaches will not charge you any fee.  You can get expert help for free!

Contact Franchise Companies

As you start to narrow down your search to a sector and then select a few franchise companies that you think might be right for you, you need to learn the way these businesses work. Call the franchise company and ask them about their process and what is necessary to succeed in this business. Your goal is to figure out whether this process will work for you. 

Interview Franchisees

The franchisees once stood in your shoes, and they will want to help. The franchise company will give you a list that includes every one of their franchisees. Prepare a set of questions to ask each franchisee, and don’t be shy. Just be cognizant of their time. You may need to make an appointment for your conversation. If you can do it in person, so much the better. Get a tour, and find out how their businesses are going. Are they making money?  Get specifics. How much? Does actual reality match up with what the franchise company told them. Where hasn’t it worked out so well for them? Why? Would they do it again? What are their tips for success?

You should also talk to franchisees who have left the system. You’ll find those names on the list from the franchise company. They may be harder to locate, but learning about how things might not go so well is extremely worth your while. Don’t skip this step!

Consult an Accountant and Attorney

These specialized professionals will help you go through the Franchise Disclosure Document, which franchise companies are required to produce. Make sure the attorney specializes in franchising. The franchise agreement can be a couple hundred pages long. If the lawyer lacks experience with franchising, he or she may not know what to watch out for to ensure you are protected. You don’t want to sign your name on any contracts without first consulting with a good franchise attorney and accountant.

And these are just the business questions. Stayed tuned for my next article on the personal questions that should be a part of your research.

© Dan Citrenbaum 2014

Dan Citrenbaum is a franchise coach and consultant to entrepreneurs, who helps people achieve their dreams as small business owners. He has a proven track record helping people select and buy a franchise or existing business. Contact Dan at dcitrenbaum@gmail.com or at 215 367-5349 and view his company website at www.entrepreneuroption.com