Financing your franchise Business
Starting a franchise business can be exciting, rewarding, and potentially lucrative. However, like any business venture, it requires careful planning and adequate financing to get off the ground and to thrive. ‘Financing’ can refer to either equity (the cash you’re putting in to start your business), or debt (money you borrow to help fund your new venture). In this article we’ll consider both sides of the financing equation and provide some pointers that we hope will help to set you up for franchising success. Ready to dive in? Let’s go…
What is financing?
It’s rare these days for any new business to be funded wholly from equity, and equally rare to be funded from debt alone. Most businesses will be funded from a combination of the two, but before we get into the mix of funds it’s probably useful for us to brush up on what makes up each side of the financing coin. Firstly equity, sometimes referred to as capital or just cash, might come from savings, or money you’ve earned selling an asset, or just about anywhere really. The key thing about equity is that it’s generally not money that you have to pay back. Sometimes you might find that friends or family might be willing to invest capital in your business, perhaps for a share of the business or profits. One thing is certain however, if you are seeking to borrow any money to help start your business it’s pretty much guaranteed that lenders will want to know what capital you’re putting in and where it’s coming from. The other side of the coin is debt. This might be a loan from a bank, a non-bank finance company, or perhaps vendor finance from the franchisor. It could also perhaps be a loan from family or obtained under some other private arrangement. The key thing about debt is that it does have to be paid back and is usually subject to a specific timescale with regular repayments.
When is a loan not a loan?
Now that we’ve looked at the simple version of debt and equity, we can consider where it all gets a little bit murky…
For example, a landlord contribution might form a significant part of your financing structure. A landlord contribution is common when leasing business premises. Landlords may agree to help cover the upfront costs of making the premises suit your requirements (the fitout), in return for the money they will receive over the lease term. Or perhaps a loan from a family member that has no formal repayment requirements, ‘pay it back when you can’ money as it were. And how for example do you treat money that has been drawn down off your home loan through refinancing or a mortgage redraw facility? Are these things debt or are they equity? Both? Neither? The answer probably depends on who’s asking.
Generally, a lender will treat a landlord contribution or loan from a family member as equity, at least from the perspective that the are no debt repayments from the business (of course you still must pay your landlord rent). Likewise, your mortgage isn’t an obligation of the business, so it’s not going to be treated simply as debt, however it may
factor into determining how much money you need to be able to pay yourself or draw from the business each month.
So, equity can be a bit confusing, but debt is just a loan, right?
Right! OK, maybe not, but it would have made for a shorter article. Debt can take many forms and might be viewed differently depending on a range of factors including what sort of debt it is (the financial product such as a line of credit or equipment loan), what’s it’s secured by (your home or specific assets or nothing in particular?) and where it’s obtained from (a bank vs. vendor finance). When it comes to debt, there are two key things to consider:
Number one, use the right sort of debt for your specific circumstances. For example, landlord contributions are often only paid after the work is complete, so while you might need a short-term loan to cover costs until the job is done you wouldn’t take out a long-term loan for this. Conversely, if you’re funding business equipment that has a long useful life, you probably don’t want to strangle your cashflow with expensive short-term finance. Number two is to make sure you have a handle on the different types of debt funding your business needs, and to understand how they will work together (or where they don’t). For example, a bank may loan you money for your business secured against your residential property, and a non-bank lender might be happy to provide you funding for your equipment and fitout even though you already have the bank finance. However, in some cases lenders may not be willing to work together as they might perceive a conflict between the finance they’re offering. One of the best approaches is to lay it out in two columns, on one side categorise and write out all the major costs in setting up your business, including franchise fees, legal and soft costs, equipment, fitout, lease bonds, etc. On the other side set out your various source of capital and debt, including savings, landlord contribution, vendor finance, equipment finance, etc. Once you’ve set it out in this way, hopefully all of your costs are less than the total of the capital and the debt, what’s left over is your working capital, the money you need to run the business until you start generating funds to pay bills.
Now that we’ve wrapped our heads around what financing is we can talk about how to get it…
Most business ventures require a combination of capital and debt to get underway, and certainty that debt (and maybe some capital) is going to be provided by someone else. So, how do we get those people to make their money part of our financing solution? We can of course try to rely upon our natural charm and charisma, but that will usually only get you so far. Once your winning smile and magnetic personality has opened the door (be it of an investor or a lender) let’s consider what else we can do to close the deal.
First things first, do your homework!
Before diving into any new business venture, it’s crucial to be prepared. Whilst franchise networks can offer a lot of support and to some extent a ‘cookie cutter’ approach, this doesn’t mean all the work is done for you. Thorough preparation not only increases your chances of securing funding but also sets the stage for a successful business future.
Most of the items touched on below are elements that you would include in a formal business plan, and indeed, a strong business plan is probably one of the best tools that you can have when it comes to obtaining finance. As part of preparing your plan, or alongside it:
- Have your house in order. Be on top of your personal finances, understand your personal credit rating and address any adverse history. Pay down personal debts if you can and stay on top of your expenses. Most lenders now will look at your banking conduct and use that information as part of their assessment. Lenders want to know that you pay your bills on time and watch where your money goes.
- Know your numbers. If you’ve ever watched Shark Tank or the Dragon’s Den, this one should already be etched in your brain. Anybody that goes in front of the camera without a good handle on their key financial metrics is doomed to be eaten alive for our entertainment. At the very least you should have a complete handle on all your costs in setting up the business, as well as a financial forecast that covers the first year or two of operation. This should be both a profit and loss statement, and most importantly a cashflow forecast. It pays to remember that profits (and losses) are not always the same as cash!
- Be realistic. Whether it’s your financial forecast or any other aspect of your business it’s important to be realistic. Include best and worst cases for things like how long it will take to get up and running. What happens if you’re three months late opening or customer take up is slower than expected? Also consider what costs might move, for example, unexpected costs in fitouts due to labour or materials are quite common.
- Be thorough. A good business plan will cover everything from the franchise concept and product, to financials, market analysis, competition, marketing strategy, and more. Find a good template and take your time to flesh it out with answers to all the questions a lender or investor might ask.
- Remember, you’re selling you. Whether you’re dealing with an investor or a lender, it pays to think of yourself as the product you’re selling. What makes you a product they’ll want to buy? Can you easily convey why this business is the right one for you, and how you’ll be able to make it a success?
It can be easy to think of all this work as something you’re doing for others, but remember ultimately, you’re doing it for yourself. A realistic and comprehensive plan can help you spot business issues and plan for them before they arise, or better yet you can make sure they don’t ever have the chance to become issues. Take guidance and input from mentors, industry experts, business groups and wherever else you can get it. Particularly ask to talk to other franchisees and pick their brains, ask them what they wish they knew starting out and what they’d do differently if they had their time again.
Look in the right places
If you’re seeking finance, it pays to look in the right places. For smaller businesses, friends and family may be the perfect investors, but for larger business ventures you might need to look further afield. If it’s investment finance you’re seeking then get out there and network, talk to people that have done it before, and don’t be shy about telling your story to people with deep pockets. Likewise, when it comes to loans it pays to go to a specialist where possible. Some banks have specialist franchise teams and there are a few non-bank lenders that have tailored their products and services to the needs of franchisees. Your franchisor will likely have several contacts that they can direct you to rather than running all over town. It also pays to remember that too many credit hits on your file from lending applications may impact your credit score and actually make finance hard to get!
In conclusion
Sorting out the finance for your franchise business is a significant step toward achieving your business ownership goals. To succeed, thorough preparation is crucial, and understanding your financing options is equally important. By developing a strong business plan, assessing your costs, and exploring various funding sources, you can navigate the path to franchise ownership with confidence. Whether you choose to leverage property equity, work with non-bank lenders, or explore other funding avenues, careful planning and research will pave the way for a successful franchise venture in these dynamic markets.
About the Author
Phil Chaplin the Chief Executive Officer of the CFI Finance Group, a specialist finance company servicing the franchise, accommodation, and fitness sectors as well as small businesses more broadly cross Australia and New Zealand.
Phil has over 20 years’ experience in providing finance to businesses across Australia and New Zealand and has managed finance companies in the private and banking sectors, he is a former chair of the Equipment Finance division of AFIA.