Funding Your First (and Subsequent) Franchise Purchase
Funding Your First (and Subsequent) Franchise Purchase
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 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 for their first (and subsequent) franchise purchases.
KEY FRANCHISE MARKETS
The most well-known business format for franchising is the retailer – the 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 exists include 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 a 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.
Because of the relatively low cost entry these franchise operations are 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 most of their financial requirements such as purchase price/set-up costs, stock requirements, debtor levels, and ongoing costs (for example, legal fees, accounting fees, stamp duty, government charges, insurance prepayments, landlord bonds etc.).
Franchisees should choose a bank lender who 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:
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.
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 property leases 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 the bank has accredited the franchise. 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 as 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 the funding may be provided by a bank or finance company.
If it is a franchise that needs a physical location, 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 family or friends
Family and friends 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 prepared to ensure there are no problems down the track.
FUNDING A SUBSEQUENT FRANCHISE PURCHASE
Multi-unit ownership can offer great opportunities for both the franchisor and the franchisee. Allowing successful franchisees to open in more locations can greatly speed up system growth for the franchisor. It can also increase local market penetration, reduce recruitment and training costs and help retain worthy franchisees by offering them more opportunities and benefits.
Some of the most successful franchisees are multi-unit owners. Successful franchisees manage to build up a strong balance sheet which allows them to take up new opportunities. They understand how to raise and use capital, and because they are already successful operators with strong business acumen and profitable franchises who can work strategically with the franchisor to get the best sites over time. They also have the ability and relationships in place to move quickly to seize opportunities if required. Having a base of trained staff, shared cost and, in many cases, another layer of management is critical. All of these factors also greatly contribute and assist with gaining funding for new projects and expansion.
Few franchisees are in a position to start by opening multiple outlets, even if the franchisor would allow them to do so. If the ultimate goal is to become a multi-site operator, it is important to discuss your plans with the franchisor, your specialist franchise banker and your accountant. The first franchise can greatly assist in funding additional outlets down the line without having to come up with much (or any) additional equity. In a typical scenario, a franchisee may open a new outlet with a plan to add a second outlet/territory within 18 - 24 months and a third a year later. Setting up the funding structure in the right way from the outset can allow the franchisee to build enough equity in the first outlet to fund the second (providing the sales and profitability projections are met and the franchisor approves them as a multiple owner). The cycle to build enough equity typically gets shorter with each new profitable outlet added.
VALUATION AND EQUITY
Part of your planning will require you to look at the valuation of existing outlets to determine the equity each might generate towards your future growth. This would normally be based on a multiple of EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation). One would need to understand the franchise system benchmarks for determining a value, which is why consulting a franchise-experienced accountant and banker is so important. It is important to understand that a business can sometimes be under or overvalued depending on where in the business cycle it finds itself, influencing the equity calculation. Multiples don’t always take into account lease issues or the need for significant capital reinvestment in the business.
Multi-unit ownership is not for everyone. It requires more financial resources, more management expertise, and extra drive and commitment from franchisees to make it work. It also requires clear planning and the ability to manage the transition from a hands-on role to a leadership and management position. Failure to do so can result in subsequent outlets underperforming and ultimately lowering the average profit of each site. But for those who do make the transition, the rewards can be substantial.
Multi-unit ownership offers the opportunity to start with a realistic investment and build a sizeable, sustainable and diversified business which can create a major asset for the future.
INFORMATION REQUIRED FOR A FUNDING APPLICATION:
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 assessment – 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.