Funding a Franchise Business
The franchise sector offers many appealing opportunities with a large variety of options available to potential buyers interested in business.
The purchase of a franchise business is a major investment decision which can be both an exciting and stressful time for a potential franchisee. Funding a franchise business is a very unique experience as both the franchisee and the financier needs to consider additional information. The fundamentals of funding a franchise business have not changed over the years however the financial management tools and information available from the internet and other sources have expanded. This makes it easier for prospective franchisees to find good opportunities and also enables franchisors to provide more relevant information to franchisees which will help find the necessary funding. In this article I will be discussing the various franchise businesses that exist and how franchisees can source funding.
KEY FRANCHISE MARKETS
The most well-known business format for franchising is the retailer – retailer model in which the franchisor promotes products or services through franchisees who adopt the franchisor’s business model and set operating practices. In 2017 the key markets in which franchising exist in includes: retail trade, accommodation and food services, administration and support services, personal services, education and training, construction, transport, financial and insurance services, healthcare, rental, hire and real estate services.
Many of these growing franchise markets belong to the service business franchise space and often these businesses do not include physical premises, physical stock or assets that can be relied upon by a financier for security purposes. These service based businesses include businesses such as a cleaning franchise business, a mowing franchise business or a pet grooming franchise business. These franchise operations often also cost significantly less to get into than a retail trade business such as an established fast food franchise chain or an established accommodation franchise chain. Bearing the low cost entry these franchise operations are also generally funded differently due to the lack of business assets that financiers can rely on. Businesses with business assets that can be relied upon can be funded in several ways by financiers, and this can also vary depending if there is a formal accreditation arrangement with the financier where a percentage of the set up costs can be funded against the business. Further detailed discussion about financing follows in the funding section.
CHOOSING A FINANCIER
After identifying the franchise opportunity the next step is to determine ways to fund the purchase. It is therefore important to work with the franchisor, financial advisor, accountant and lawyer to find out what is achievable, what is realistic and to put together a comprehensive business plan to achieve the right funding available to you.
A business plan will assist franchisees to understand the majority of their financial requirements such as purchase price/setup costs, stock requirements, debtor levels and ingoing costs (for example, legal fees, accounting fees, stamp duty, government charges, insurance prepayments and landlord bonds).
Franchisees should choose a bank which has expertise in the franchise sector and which provides a range of financial products and services that the franchise business will need.
In all probability this will not just be one simple loan but will involve a combination of two or more of the following options:
Business Term Loans
Bank business term loans are repayable over a specified term and are therefore a well suited finance for the initial purchase, or the set-up of a business. This can include funding for the franchise fee, initial stock, fit-out and equipment costs. Care should be taken to match the term of the loan with the remaining term of lease and franchise agreements to ensure that business debt is fully paid at the expiry of these agreements.
Generally business term loans can be secured against equity in the borrower’s residential property or in some situations the borrower may be able to use the assets of the franchise as part of the security mix. This will depend on the arrangements between the bank and the franchisor and if an accreditation is in place. In practice, if an accreditation is in place this means that a potential franchisee needs less of their own money to get into a franchise business, they can secure part of the investment against the assets and future cash flow of the business.
Short Term Funding - Overdraft
This type of finance is suited to cover cash flow fluctuations. Overdrafts may be suitable for seasonal business and franchises with a high level of debtors or stock. This facility is generally secured by the borrower’s residential property.
Equipment Finance and Leasing
Many franchise businesses require specialised equipment such as pizza ovens, coffee machines, cool rooms, display cabinets and vehicles. Equipment finance is normally managed using the equipment as security and over a term within the useful working life of the item being funded. Equipment finance has the advantage of lowering the equity/investment required, as funding could be up to 80 - 100 per cent of value (if new). This is a facility for a specified term secured by equipment and may be provided by a bank or finance company.
This is used extensively, particularly where long-term funding is required or when funding is sought for service based businesses or a franchise operation that may not have a formal accreditation with a bank in place. It may require an owner’s contribution: for example, free equity in a property or the total funding can be secured against the property. Other forms of security or third party guarantees can also be considered. Secured lending would usually be the cheapest option and the part of the loan secured against property can often be done over a longer term, which can lower monthly repayments and ease cash flow pressures.
In some instances another possible source of funding could come via the landlord in the form of fit out contributions and set up costs.
Loans from friends or family
Friends and family can become investors in your franchise operation if they have the willingness or means to invest. Even though your investor or financier may be your family and friends, it is best to have formal documents still prepared to ensure there are no problems down the track.
Information generally required for a franchise loan application is as follows:
• Copy of the proposed Franchise Agreement.
• Detailed list of set up costs – for greenfield sites only.
• The applicants Curriculum Vitae detailing their background, experience and qualifications.
• A detailed Business Plan, which must include 12 month’s cash flow and profit and loss projections.
• Copy of the proposed Lease Agreement.
• An executed Business Loan Application – provided by the bank.
• The applicant’s personal tax returns for the last two years.
• The last two years’ Tax Return and ATO assessments – for existing business.
• Tax portal printouts (1 year) - for existing businesses.
• A copy of the sale contract - for existing businesses.
• The last 12 months’ bank loan and transaction account statements – for refinance applications.
• Client contribution details and evidence of any savings.
Westpac has supported the franchise sector in Australia for over 20 years. The growth of a specific franchise system is supported by providing streamlined processes for lending, as well as access to other lending transactional solutions. The bank also has a national network of franchise specialist business bankers who are able to deal with specific day to day needs of the franchise customer.
Labrina Tsekouras is the Westpac Senior Business Development Manager for Victoria and Tasmania and specialises in the franchising sector.
Contact Labrina at:
The information contained in this article is intended as a guide only and is not intended as an exhaustive list of matters to be considered. Persons entering into franchise agreements should seek their own independent legal, accounting and other advice.