Is the Item 7 working-capital line the same as a reserve?

No. Item 7 estimates the open, including additional funds. A reserve is cash you still hold after that spend. I keep them in different accounts.

What if the franchisor says three months is enough?

Treat that as a claim to test. I still want six months of fixed costs unless recent openers can show a boring ramp and name the costs in it.

Does the reserve change if I am semi-absentee?

It gets stricter. You are paying a general manager from the start, and you may not be in the unit to catch a slow week. Price that wage into the fixed-cost number before you decide the reserve is extra.

Buyer questions

How much liquidity should I retain after opening?

The cash you should still have the morning after opening is not the Item 7 total. Item 7 is the franchisor's estimate of what it costs to get the doors open, and the working-capital line inside it is usually a short, tidy ramp.

My rule of thumb, after 30 locations, is to keep at least six months of fixed costs in a separate account on opening day. If the deal only works by spending that money to finish the build, you are not ready to open.

Three piles people mix together

The first pile opens the business. Franchise fee, build-out, equipment, deposits, inventory, grand-opening ads. That is Item 7. The low end of the range is a marketing number. I start at the high end, then I ask owners what they actually wrote checks for.

The second pile is the ramp. Item 7 includes additional funds for the opening period. The FTC Franchise Rule makes a franchisor disclose that estimate. It does not make the line survive a late landlord, a bad hire, and a quiet first quarter. I have never seen all three go right together.

The third pile is liquidity after opening: cash you do not spend to get open, so payroll, rent, royalties, and the loan still clear if sales are late. Move it to finish construction and you did not have a reserve. You had a hole.

The six-month rule of thumb

Six months of fixed costs. Not six months of hoped-for revenue. Fixed means rent and CAM, insurance, debt service, software, royalties and the brand fund on a conservative sales guess, and the payroll you cannot cut without closing.

If a paycheck still covers the house, I leave your draw out of those six months. If the franchise is how the family eats, a modest draw goes in. Mixing the two is how a spreadsheet starts lying. I want this answered in writing:

High end of Item 7, plus what the last few openers actually spent.
Six months of fixed costs in cash, in an account construction cannot touch.
A named backup for the first general manager.
Insurance, deposits, and the first franchise payments on a calendar.
Household bills for the same six months, if the paycheck is going away.
The cash a lender still wants to see after you inject equity.

Questions worth asking out loud

Ask the franchisor, then ask owners what was in the bank the Monday after opening, and again ninety days later. A letter is not cash. Undrawn loans and retirement money still in a plan do not make payroll. If you are keeping a job, a real general manager belongs in the fixed costs. That week is what semi-absentee really requires.

An SBA 7(a) loan can sit in the stack when the brand is on the SBA Franchise Directory. The SBA says a listing is not an endorsement and does not mean the business will succeed. Read Item 7 the way I do in FDD red flags I learned the hard way. Running out of cash on the open is also one of the mistakes that cost first-time buyers.

What does the additional-funds line assume, in months, and which costs sit inside it?
What did recent openings spend against the Item 7 high?
How many months until a new unit covered fixed costs from operations, not from the owner's pocket?
If the first six months come in softer than the middle of Item 19, what breaks first?
Do you require cash after opening, or only a net-worth figure to qualify?

FAQ

Is the Item 7 working-capital line the same as a reserve?: No. Item 7 estimates the open, including additional funds. A reserve is cash you still hold after that spend. I keep them in different accounts.
What if the franchisor says three months is enough?: Treat that as a claim to test. I still want six months of fixed costs unless recent openers can show a boring ramp and name the costs in it.
Does the reserve change if I am semi-absentee?: It gets stricter. You are paying a general manager from the start, and you may not be in the unit to catch a slow week. Price that wage into the fixed-cost number before you decide the reserve is extra.

Sources

Keep reading

Pressure-test the reserve before you sign

If you have an Item 7 and a real budget, I will read them like an operator and tell you if the leftover cash is a reserve or a wish. Book a call, or start with the advisor if you are still sorting what kind of business should fit the life.