Are Many Franchisors Underestimating
Startup Costs In Item 7?
by Ed Teixeira
Item 7 is one the more important disclosures in the Franchise Disclosure Document, since it estimates the investment a franchisee will make in a
I know that this subject could open up a proverbial can of worms and we may never know the answer to an important question in franchise disclosure. How
accurate is Item 7 Initial Investment and how many franchisors underestimate the entries? Is it a very small number of franchisors? Are some estimates
lower than they should be, as a result of mistakes or inaccurate numbers? Are there franchisors that "shave" the numbers so they are on the low end?
Obviously, it makes no sense to underestimate the investment a specific franchise requires, since it has critical implications for both a franchisee and
the franchisor. Yet, from personal experience I know that some franchisors have understated Item 7, for obvious reasons. The lower the investment the
larger the pool of franchise candidates and the more likely a certain franchise may appeal to a candidate when their investment capital is at a certain
Although Item 7 shows an estimated low and high range for most entries, if the low entry is underestimated odds are the high entry will be as well.
Hopefully, all franchisors have the good sense to portray as accurate an Item 7 as possible based upon experience and fact. A failure to fulfill this
requirement can result in new franchisees entering the franchise system being undercapitalized from the start.
Item 7 Explanation follows:
The FTC requires that every Franchise Disclosure Document includes a schedule, under Item 7, that provides prospective franchisees the estimated investment
in that franchise. Initial and on-going franchise fees are in Items 5 and 6. In Item 7 franchisors are not required to list every type of fee or expense
that might be part of the investment in the franchise. Instead, it contains the likely investment needed to start the franchise. The FTC requires that Item
7 list typical start-up expenses, such as the initial franchise fee; training expenses; real property (whether purchased or leased); equipment; beginning
inventory; and business licenses and related fees.
In addition to these typical expenses, franchisors must itemize and identify any other specific required
payments such as additional training, travel, and advertising expenses that franchisees will incur to begin operations. The information will vary somewhat
depending upon the type of franchise. It's important to keep in mind the words "estimated" and "typical." You should use this information to develop your
own investment number with your accountant or advisors. T
he last entry in Item 7 is Additional Capital or Funds which is an estimate of the low and high
amount of funds a franchisee may require to meet their personal expenses. This is an important category in Item 7 and one often misunderstood. In this
category, franchisors must list any other required expenses that franchisees will incur both before operations begin and during the initial period of
In general, the time period most often used is three months. When a franchise candidate does a business plan and estimates future capital
requirements they should remember that the Additional Capital estimate is usually for 3 months and few businesses reach break- even in 3 months.