I’m starting a Franchise Business – What can I finance?
When it comes to funding the expenses associated with your business start-up it is sometimes easy to think ‘it’s all the same pile of sand’; you’ve got all your costs (franchise fees, legal costs, equipment, property bond, fitout, stock, working capital) and you’ve got some money to cover those costs (savings, friends & family, investors, landlord contributions, external finance).
When it comes to funding the expenses associated with your business start-up it is sometimes easy to think ‘it’s all the same pile of sand’; you’ve got all your costs (franchise fees, legal costs, equipment, property bond, fitout, stock, working capital) and you’ve got some money to cover those costs (savings, friends & family, investors, landlord contributions, external finance). Whilst it might be easy to think that so long as money-in equals money-out everything will be fine, the reality is a little more complicated. Knowing what you need to spend your capital (cash) on versus what costs you can borrow for could be the difference between getting your new venture off the ground or not.
Working Capital – It’s tempting to leave working capital to last, after all for most people ‘working capital’ simply means the cash you’ve got left over for running the business once you’ve paid for everything else. It can pay however to deal with working capital first. Most lenders do not want to provide working capital finance to brand new businesses, you’ll usually need at least 6-12 months trading and often more. Give your lenders (and investors) confidence that you’ve planned for enough cash to cover the all-important first six months in business. Having a detailed cashflow forecast can be a big help here and remember to build in a buffer if your revenue in those early days isn’t what you’re aiming for. Aim to have the right amount of money in the bank the day you open the doors and tell your lender “I’m saving that for working capital”.
Franchise Fees – This is another big-ticket item that is often hard to finance. The franchise fee is usually your first major expense and a big chunk out of your cash savings going out the door. Having paid your franchise fee shows your commitment to your new business and of course secures your new territory. Most financiers will not want to fund franchise fees however there are exceptions, and it pays to ask a few questions. Firstly ask the franchisor if they work with or recommend any particular financiers. If the lender has a good relationship with the franchisor they may be more willing to take on the risks of funding ‘intangibles’ like franchise fees. If you need to prioritise cash-flow you can also ask the franchisor if they have any arrangements around split or deferred payments for franchise fees.
Property Bonds – If bricks and mortar premises are part of your new enterprise then some form of rental security bond is pretty much a given. For smaller bonds it’s often easier to use cash but if you do then that’s a chunk of money you can’t access for a long time. Most larger bonds are managed with a bank guarantee. With a bank guarantee your bank provides the landlord with a document confirming that they will make payment on your behalf for any amount owed up to the guaranteed amount, you’ll pay interest on that guaranteed amount for as long as the guarantee is in place. Typically, you’ll need to already have a relationship with the bank and they will need some sort of collateral for the guarantee, fo example, you may be able to tie the guarantee to your personal mortgage. Although there are fees and interest to pay it does mean that you conserve your cash.
Fitout and landlord contributions – Fitting out your new business can be an expensive exercise. Typically banks shy away from funding fitouts but you may have more success with an independent lender, particularly if they’re familiar with your franchise system or have a relationship with the franchisor. When you’re looking for funding for your fitout it pays to remember that a fitout by itself may be harder to get finance for than a fitout plus all your equipment, even if you’re borrowing more. This is because lenders generally consider fitout to be “unrecoverable”. That is, it can’t be sold on to someone else for good value if you run into trouble. The lender will look at the overall security position of the loan, so in practical terms a lender may be more willing to loan you say $100,000 to cover $50,000 of fitout and $50,000 of equipment, than just $50,000 for the fitout.
A trap that many new businesses fall into is finding a lender for all of the equipment component and then realising that no other lender will finance the fitout component by itself, so make sure you have all of your finance requirements met before your start drawing down funds.
Landlord contributions can often significantly offset the cost of your fitout. A landlord contribution is often negotiated as part of a property lease where the landlord will pay a portion of certain fitout costs. If you are receiving a landlord contribution you need to look carefully at when the funds will be paid. It’s common that you will not receive the money until you have completed the fitout, and it’s up to you to pay all the costs to builders and other contractors along the way. If this is the case some specialist lenders may provide you with funding to bridge that gap and to make payments along the way, with the landlord contribution being paid straight to the lender on completion. This is often referred to as bridging finance or landlord contribution funding.
Asset / Equipment Finance – I’ve already touched on this when looking at fitout finance above. Banks and finance companies are usually most comfortable funding assets that are referred to as tangible and recoverable. This basically means things that the financier could resell the assets in the event that you fail to repay the loan.
There are still some bases to cover when it comes to asset finance. Firstly, many banks have tight restrictions on the types of assets they can finance, and they may not be comfortable covering costs like installation or shipping. To avoid surprises, it pays to give the financier a copy of your quotes or invoices to make sure they’re going to lend you the full amount. Secondly, most financiers have strict rules around supply of assets, if you’re buying any assets privately, directly from overseas, or if you’re buying used assets you need to cover this off with your financier early and ensure you understand any special terms and conditions that apply. Finally, it can be very useful to understand the finance product offered and how it can be used to your advantage, for example a loan might allow you to buy equipment and claim depreciation, whereas a lease could mean the financier is willing to lend you’re a little bit more in total.
So, some tips in summary:
- Talk to your franchisor about who they recommend or look for a specialist financier that understands the franchise industry.
- Try to plan all of your costs and finance before you spend or borrow any money.
- Don’t rush to finance your assets if you haven’t arranged finance for other things (like fitout), you may get a better deal bundling all of your requirements together.
- Financiers want to see that you’re spending (and conserving) your cash wisely. They’ll often lend a little bit more to someone that is saving their pennies and has a clear plan (cashflow forecast) than to someone that’s spent everything they have and then gone looking for more.
Phil Chaplin is the Chief Executive Officer of the CFI Finance Group, a specialist finance company servicing Australia’s franchise, accommodation, and fitness sectors as well as small businesses more broadly.
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.