last updated 06/04/2016
FUNDING a food business
last updated 06/04/2016
Daniel Cloete of Westpac looks at the options and advantages for new franchisees
The food sector has always offered some of the most attractive opportunities in franchising and, as the cover story in this issue shows, there is a huge variety of options available to potential buyers. When it comes to funding a food business, though, there are some unique aspects that franchisees – and their bank – need to consider. Let’s look first at some of the issues that affect a franchise’s ability to service its borrowing.
The profitability of a food franchise is dependent on a number of factors: sales performance, gross profit (GP), food cost, wages and rent. This profitability in turn determines the ability of the business to obtain funding and reward its owners for the investment risk.
Sales are also influenced by many factors, including the drawing power of the particular brand, location, price, availability of parking, service, atmosphere, etc. While recent statistics show growth for the food & beverage category as a whole, there is considerable variation between different sectors, and between individual brands in the same sector.
However, even if sales are good that’s not the whole picture, as generating sales is unlikely to lead to increased profitability unless you can also maintain or improve the Gross Profit margin.
Understanding food cost and how to control it can be the key to success in the food industry. The fact that franchisees can compare their cost of food with others in the same franchise system (benchmarking) is a really important advantage when it comes to fine-tuning and getting it right. Lowering the food cost increases Gross Profit margin, which influences the bottom line and debt servicing ability of the business.
Many franchise food brands have very sophisticated measurement tools and management information systems to assist with controlling food costs. These break sales down into categories or even specific items, so that the franchisee is aware of what contribution each category or item makes to their Gross Profit. GP is also influenced by factors like wastage and shrinkage (theft), which need to be carefully watched.
Of course, the volume of food purchases of the larger franchises enables them to negotiate much better prices than individual businesses can manage, lowering their food costs and increasing their competitiveness and profitability.
Preparing and serving food is a relatively labour-intensive activity and the profitability of any business is damaged if the business is over-staffed. Getting the wages right compared to other similar food models is very important, which is another area where benchmarking is vital.
When we look at funding the re-sale of existing businesses, we find that this is one of the components which franchisees have control over that they tend to get wrong very often. By simply fixing the overstaffing and/or working in the business as an owner/operator, it is sometimes possible to increase the profitability significantly.
For fast food or fast casual dining options, lots of foot or vehicle traffic may be very important to drive sales. Where the business is a destination in itself, good parking matters more, while if the business is mobile or delivery-based, the location can be more flexible. All of this has a direct impact on the rent payable.
Mall locations can present particular challenges because the high rents there, along with high operating and other expenses may push up the rent as a percentage of total turnover. This has to be carefully considered before purchase because it creates a large fixed cost component which can have a direct impact on profitability and the ability of the business to weather downturns in sales.
When considering buying a food franchise, then, all of the above factors need to be taken into account. It’s therefore important to work with your franchisor, accountant and banker to find out what is achievable, what is realistic, and to put together the best funding for your own specific needs. In all likelihood, this will not just be a simple loan but will involve a combination of two or more of the following options.
Term loans can be used to fund the purchase of the business or the set-up, franchise fee, fit-out and equipment costs. Typically, three-to-five year term loans are used, secured against the business and cashflow. The funding term would be limited by the term of the franchise agreement or premises lease. A business term loan is often a good way to fund the business; by funding against the business cashflow, it also lowers the investment required by the owner.
Equipment finance and leasing Most hospitality businesses require specialised equipment such as pizza ovens, coffee machines, display cabinets, vehicles or cool rooms which have a limited useful lifetime. Equipment finance is normally done using the equipment as security and over a term within the useful working life of the item being funded. Equipment finance funding has the advantage of lowering the equity/investment required, as funding could be up to 80-100 percent of value (if new). Leasing equipment such as computers may have some tax advantages as well.
Some banks (like Westpac) offer equipment finance and there are specialist leasing and equipment finance companies in the hospitality industry. Some equipment manufacturers may also offer funding. When introducing new equipment, many franchisors negotiate a funding package for franchisees through their bank.
One thing to remember is that total debt servicing doesn’t change and equipment funding rates can be somewhat higher than other forms of funding. It does, however, allow you to preserve your precious equity – always a consideration, as it’s important to have enough working capital to see you through the early days. Equity can also come under pressure from the need to secure rental or purchase bonds; something that has become more common in recent years.
Secured funding This is used extensively, particularly where long-term funding is required. It may require an owner’s contribution: for example, free equity in a property, or the total funding can be secured against property. Other forms of security or third party guarantees can also be considered. Secured lending would be the cheapest option and the part secured against property can be done over a longer term, which can lower monthly payments and ease cash flow pressures.
Short term funding Where the restaurant or food outlet has a highly seasonal component – for example, where there is a large outdoor area that is only busy in summer, or the outlet is located in a holiday town that is only busy in season – sales will vary. Costs such as rents are fixed, though, so the business may require funding until the cash flow turns positive again. It’s wise to consider this at the start and plan accordingly.
Other possible sources of funding for food businesses include fit-out contributions from landlords and, in the case of bars/restaurants, set-up contributions from the breweries. Ask your franchisor.
The Franchise Advantage
In conclusion, the advantages that franchises offer in collective purchasing, marketing and benchmarking lower the business risk considerably for new entrants and support profitability. As a result, a bank with a specialist franchise unit like Westpac is often prepared to lend against the existing or even new franchised business itself, based on its industry knowledge and the record of the franchise system and the other existing franchisees.
In practice, this means that potential franchisees need less of their own money to get into business and can secure part of the investment against the assets and future cash flow of the business. If you are looking at getting into the hospitality sector, then, buying a franchise may enable you to afford a much larger food business than if you were setting up an independent outlet.
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 professional legal, accounting and other advice.
This advertorial is taken from Franchise New Zealand magazine Volume 23 Issue 1
Contact details for Westpac
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