Financing your franchise

Obtaining the funds to buy an established franchise or to set up a new franchise outlet is fundamental. Senior banker, Rod Nuttall, outlines some of the issues to be considered when approaching a bank for funding.

OWNING A FRANCHISE can be very rewarding and the most successful franchisees are those who have performed due diligence from the very start – before they actually commit to the purchase.

The ability to finance a franchise business effectively lies at the heart of its success. Finding the right banker to assist new franchisees in their venture, as well as establishing good, strong relationships is an important start. Not only do bankers enable franchisees to access capital and other necessary financial services involved with the venture, they also provide invaluable support and knowledge.

Some financial institutions have dedicated teams of franchising specialists who have in-depth knowledge of specific franchise systems. When it comes to securing a loan, it’s considered more acceptable in terms of risk for a bank or financier to lend to a franchisee setting up within an existing franchise system. This is because the existing franchising system has already proven its ability to reproduce its business in various locations, so the risk of the investment is perceived lower than a start-up.

When it comes to running a franchise, there are a number of operational issues and aspects to learn. These are often explained and taught to franchisees by franchisors or other franchisees in the system. In contrast, when it comes to the financing of a prospective franchise, there are really two critical financial aspects that a franchisee needs to have an understanding of, that is: capitalisation requirements and cash flow drivers.

Under capitalisation, funding a franchise can be easy but also potentially a fatal mistake for first-time franchise business owners. Without sourcing the right capital, franchisees could struggle to satisfy all of their creditors. Put simply, if bills can’t be paid, the operation could flounder and is more than likely to fail.

Pre-purchase planning
When the franchisee carries out due diligence on the franchise system, part of this process is to make sure that professional advice is sourced from the right people with franchising experience. New franchisees should speak to existing franchisees, the franchisor and their bank to find out who they’ve worked with in the past.

Unless new franchisees are in the position to finance the start-up of a franchise with their own funds, they would need to approach the bank for a loan. To give new franchisees the best start, it is important to ensure that loan applications are accompanied by well organised financing proposals that demonstrate an understanding of the business and financing needs, also the expected performance of the business.

It is important to remember that a well-researched, well-presented and articulate business plan will be viewed more favourably by a bank.

There are two routes a prospective franchisee can take: setting up a totally new franchise outlet, or buying an existing outlet. Whichever is chosen, the solution to overcoming the risk of under capitalising a business at start-up time is to clearly understand the total amount required to fund a store opening.

If franchisees are keen to set up a new franchise outlet, the franchisor should be able to outline the costs involved in the franchisor disclosure document. These include:

• Franchise fee
• Construction costs
• Leasehold improvements
• Equipment
• Pre-opening costs (including local store marketing)
• Franchise lead training costs; and
• Suggested working capital.

Remember, new franchisees aren’t just buying any business, they are buying their own business.