June 13, 2022 by Adam Hoeksema
If you are considering starting a business in 2022, a franchise might be a great option for you. According to Statista, there are just over 750,000 franchise establishments in the United States.
Number of Franchise Establishments in the US
One great thing about franchises is that they are required to provide a franchise disclosure document which provides detailed financial information, among other things, about the franchise. The information in the FDD can be used to help you create your own financial projections. In this article, I am going to show you how to utilize the FDD to help create financial projections.
Why create financial projections for a startup franchise?
As you consider opening your own franchise, creating a set of financial projections can be an incredibly valuable exercise to help you avoid making a major financial mistake. Creating projections will allow you to understand the key levers that impact profitability for the business, and help you answer the all-important question “how much money can I make?”
In addition, if you are trying to secure bank financing for your franchise startup, you will likely be required to provide a set of financial projections with your loan application. So, this is likely a necessary evil that you will have to work through at some point.
Franchise attorney, Stephanie Maris, has this to say about the importance of financial projections for prospective franchisees,
“Franchisors are limited in what they can say to prospective franchisees in terms of financial projections in Item 19 due to the Amended Franchise Rule, so it is very important for prospective franchisees to do their due diligence in reviewing the information that is provided and preparing a pro forma which includes all the various fees that will have to be paid to the franchisor so that they can get a better overall picture of the business opportunity.“
How to create pro forma financials for your franchise
The best place to start when working to create projections for your franchise opportunity is to start with the FDD (Franchise Disclosure Document).
What is a Franchise Disclosure Document (FDD)?
According to Investopedia,
“The franchise disclosure document (FDD) is a legal disclosure document that must be given to individuals interested in buying a U.S. franchise as part of the pre-sale due diligence process. The document contains information essential to potential franchisees about to make a significant investment.”
What is included in an FDD?
There are 23 specific sections of a Franchise Disclosure Document that range from company history, any relevant litigation related to the franchise, franchise intellectual property, and financial information. Here is the full list of FDD sections. We are going to focus on the items in the FDD that contain relevant financial information.
What sections of the FDD include financial information?
The following items in an FDD contain financial information:
Item 5: Initial Fees - This item outlines the initial franchise fees you will be required to pay as a franchisee. This will be part of your franchise startup costs.
Item 6: Other Fees - This item outlines the ongoing franchise fees or other ongoing costs associated with operating the business.
Item 7: Initial Investment - This item should provide a table that includes all the startup costs, or potential ranges of startup costs required to open the franchise.
Item 10: Financing - This item might be relevant for your financial projections if the franchise offers financing options to the franchisee. This section would give you details on interest rates and terms of financing that would then need to be included in your projections.
Item 11: Franchisor’s Services - This item will outline the services that the franchisor will provide to the franchisee. This is important for your projections because if the franchisor provides advertising services, new employee training or software used to run the business as part of the franchise fee that you already pay, then you won’t need to budget for these costs in your projections. It is important to compare the services you will receive between franchises when you are trying to determine which franchise might be the best fit for you.
Item 19: Financial Performance Representations - In this section the franchisor is able, but not required, to provide information on individual unit financial performance. If the franchise you are exploring does provide Item 19 information, this will be key for you to use as you create your own projections.
What if your FDD doesn’t provide detailed financial information in Item 19?
If the franchise opportunity that you are pursuing does not provide detailed financial performance information from other franchisees, that may or may not be a red flag. With many of the larger franchises, they simply don’t need to provide that level of information, so they share as little as possible, and they are still able to attract new franchisees. If it is a smaller, newer franchise, and they don’t provide detailed financial information about the performance of other franchisees, it might be a red flag. I would suggest looking at competing franchise concepts to see if their FDD provides more detailed information. If you can find financial information from a competitor that would at least be a good starting point for your projections, some data is better than nothing.
How to create projections from FDD data?
Now that you know where to find all the relevant financial information in the FDD, it is time to complete a set of projections.
ProjectionHub provides a number of financial projection templates for just about any type of business, so you can start by finding the best fit financial projection template for your franchise type.
Then take the startup costs, operating costs, franchise fees, and any other revenue or financial information you were able to gather and use those assumptions to complete the template.
You will also want to include your specific financing plan assumptions in your projections. Whether you are raising investment, personally investing into the business and/or securing a small business loan, you should include those details in your projections. Additionally, you should include custom assumptions for your physical space if applicable. Are you renting space, purchasing a building, how much renovation is required, what equipment is needed, etc. All these assumptions will be unique for each business owner and should be considered in your projections. Your unique financing structure and the details about your location can have a dramatic impact on your potential cash flow and profitability.
If you would like some help filling out our template, we would love to take your FDD, your specific plans, and use that to fill out one of our financial projection templates for you. You can check out our custom financial modeling services and request a quote for help with your projections.