Funding tomorrow’s franchisees

 

Franchise finance remains of great importance as the majority of franchisees need to borrow to complete their transactions. Whilst the major banks continue to dominate, new players, new approaches and new rules are emerging.

A process or review, known as an ‘accreditation’ has been in place across all major Australian banks for many years. The essence of an accreditation is the bank having a degree of knowledge and comfort with a particular brand that enables them to process transactions faster and more consistently for franchisees. This generally includes an exhaustive (and often costly) process of sourcing and analysing information.

Whilst the process has been similar across the banks, there have been swings in their appetite, resource investment and the number of accreditations maintained which has been the source of some frustration, and at times confusion, to the franchise sector. Australian banks have continued to grant new accreditations in recent years however the general trend has been one of rationalisation with an increasing focus on the cost of processing and maintaining accreditations. Apart from the obvious consequence of poor loans, brands that cannot place enough (revenue generating) transactions with the accrediting bank can also face the withdrawal of that accreditation.

Like many aspects of franchising, the giant US market* can provide some useful insights into where Australia may be headed with franchise finance. While the US also has accreditations (lending programmes) these are typically only provided by the largest of banks with much of the franchise finance demand satisfied outside of these larger bank accreditations.

The absence of internal accreditation teams in all but the largest of US banks has created an appetite and dependence on external and objective information. For example, in the US there is a multitude of community and regional banks that contribute to the 7,000 lenders accessing information on some 3,500 active franchise brands through the Franchise Registry. This information can include eligibility reviews for government backed lending programmes and Franchise Underwriting Reports to support individual transactions.

Locally, in addition to major banks we are now seeing the growth of specialist equipment type financiers, the reinvigoration of interest from some regional banks and the arrival of genuine alternative lenders in the franchise funding space. Whilst this is all pointing to a reduced reliance on the major lenders and traditional accreditations much depends on the lenders comfort with measuring and assessing performance outcomes.

THE IMPORTANCE OF PERFORMANCE STANDARDS

While both US and Australian lenders are ready to make new loans, finding borrowers they deem to be qualified still seems to be a challenge for them. Franchised businesses have an advantage over independent small businesses in that they have the ability to statistically and quantitatively measure a brand’s performance history. This provides franchisees with a competitive advantage when securing financing as the creditworthiness of the system is addressed, in addition to the borrower’s qualification.

There are three areas that lenders want to assess in addressing system creditworthiness: unit economics, system performance, and franchisor performance. Lender willingness to extend a loan declines as a system’s credit risk becomes less transparent. Franchise systems with a proven track record have the best access to the credit market, compared to other franchise systems and independent businesses that are competing for the same loan.

The key to lender willingness in this environment centres on information. As banks are slowly changing from a mindset of not losing money to positioning to competition, greater underwriting due diligence remains and much more analysis and paperwork is required. It is becoming more apparent that the ease of finance access increases as the prospective franchisee becomes more experienced, operates a larger number of stores, has a proven credit history, and partners with a creditworthy franchisor.

While much has gone into underwriting the borrowers, it is becoming increasing important to also evaluate the brand. Franchisors are being assessed on their history of closed units, assistance with struggling units, systemwide growth, and category growth within the industry. The  ability to provide a comparative historical risk analysis of both franchisor and system performance will certainly be a consideration and provide a competitive advantage for franchisors who have positive performance trends.

The importance of a strong brand is more apparent for first time franchisees. A strict franchisee selection process and a wellstructured franchisor support structure provide lenders with reassurance. Knowing the type of infrastructure that is in place to provide franchisee support helps lenders gauge risk when the borrowers are on the higher end of the risk curve due to a lack of credit and performance history. A partnership with a strong brand becomes a mitigating factor for more risky borrowers, such as first time prospective franchisees.

Even for borrowers that have no problems accessing finance, brand still plays an important role as lenders are willing to structure better terms and lower interest rates for franchisees operating businesses in brands that are strong and financially sound. However, the definition of what constitutes strong or good is vague and no standards have yet been set in franchising that drive performance.

The uniformity of franchise systems lends itself to comparative metrics, such as returns on investment, sales growth, unit profitability, and operating costs, which will be key in guiding best practices that result in successful operations and growth. The industry needs to define, standardise, and lead the efforts towards measuring performance. Otherwise, it will be forced to follow a path created by others.

Darryn McAuliffe is the CEO of FRANdata Australia and has over thirty years’ experience in the banking and finance sector. He is a CPA, CFE and experienced former bank executive across business banking, risk management and franchise industry specialisation.

FRANdata has been supplying independent and credible information to support key franchise decisions for more than twenty five years and operates the Australian Franchise Registry™.

For more information:

02 8346 6093
dmcauliffe@frandata.com.au
www.frandata.com.au
www.thefranchiseregistry.com.au

*FRANdata research estimates US $30.1 billion is required to support US franchise transactions of which 75% is provided by conventional lenders, 4% by alternative (market place type) lenders and the remaining 21% through the SBA (government supported lending) program.