last updated 22/07/2019
Funding Your Franchise
last updated 22/07/2019
Westpac’s Daniel Cloete offers advice on some common banking issues for franchisees
Whether you’re starting-up a new outlet or taking over an existing one, as a franchisee you’ll face a number of opportunities and challenges on the financial side. That applies both to start-up funding and to day-to-day operations, so it’s worth educating yourself on the most common issues in advance. That way, with the guidance of your franchisors, your accountant and your franchise-specialist banker, you can focus on building a truly successful business.
According to the 2017 Survey of Franchising, franchisors identified a number of franchisee funding issues as being of most concern.
The biggest problem regarding growth funding, identified by 59 percent of franchisors, was lack of equity from potential franchisees. (equity is money you put in; funding is money you borrow). This means people who otherwise meet the ideal criteria for new franchisees not having sufficient equity to invest, or the business not being able to service the debt required if appropriate security is not available.
About a third of franchisors also identified as key funding issues problems with:
• accessing funding
• a lack of understanding of franchise models amongst some lenders;
• (lack of) access to cash flow lending.
equity and debt servicing
Most people buy businesses using a combination of equity and funding. Unfortunately, if you don’t have a sufficiently high proportion of the required funds as equity, you may have to look elsewhere – perhaps start with a smaller business and work your way up. You see, although it’s perfectly normal to borrow money to fund your way into business, you should only borrow to a level your business can afford. Neither you, nor the bank, nor the franchisor will be happy if you incur more debt than the business can service.
The amount of equity you need for any franchise may depend on the proposed funding structure. For example, if you are using a house as security, a longer term would be possible, thereby reducing the debt servicing amount. Where funding is secured against the cash flow of the business (see below), the length of the franchise agreement or lease terms may limit the funding term – increasing the regular servicing requirement. Equipment finance can reduce the level of upfront investment required, but the appropriate funding term would vary according to the useful working lifetime of the vehicle or equipment. No matter how attractive a longer term may seem at first, you don’t want to go on paying for a coffee machine three years after you’ve had to replace it with an even more expensive one.
The best way to access the funding you need is to work with a specialist franchise specialist banker who understands the business model of the specific franchise you are looking at. They will know what’s realistic and be able to make suggestions based upon your own particular situation. They may also be prepared to offer some cash flow lending against the strength of the franchise brand and business model.
Once your franchise is up and running, you’ll be busier than you can possibly imagine: building your client base, serving customers, managing your staff and learning the 1001 things you’ll need to do every week as the business grows.
On the financial front, one of the biggest challenges for small business owners is managing cash flow. Factors that affect cash flow include the timing of tax payments, seasonality of sales, bad debts, holiday payments and unexpected repair or other bills. New businesses tend to overstaff in the beginning, for various good reasons, and costs could be abnormally high. This is another reason why you really need a funder that understands the franchise model.
If you suddenly need a temporary overdraft for the business, your banker will want to know the reason (eg. emergency repairs on equipment and how it will be cleared (eg. from future profits as proven by your management accounts). They will definitely not be keen to fund you because your debtors are not paying you (controlling debtors needs to be one of your major focuses) or funding losses – unless there are very good reasons.
While retail franchises tend to have positive cash flow from day one, some other models such as project management or equipment rental may take a long time to reach break-even and can suck up more capital as they grow, creating negative cash flow. If your business is one of these, the shortfall will need to be funded until you reach break-even. An experienced accountant should be able to help identify your cash flow requirements and a banker who understands the business model can then fund the working capital required to manage shortfalls.
In general, you shouldn’t make capital expenditure out of cash flow unless you are really sure the business can afford it. Just because there is money in the bank, it doesn’t mean you can spend it on equipment or upgrades, or you may find that there is suddenly no money to pay the wages or tax due at the end of the next month. Capital expenditure is usually best made using the right funding product over the right term. The same applies to businesses that experience strong seasonal sales: a retailer in giftware may need additional working capital to secure stock in September if most of their sales are in the Christmas season.
Business management has become much easier in recent years thanks to accounting packages like MYOB and Xero, and some really good add-on reporting software. Many franchises offer extensive stock-control, marketing, invoicing, online training and other systems. Understanding trends in basic KPI’s in a timely manner, including Gross Profit margin, wages and other costs, allows the franchisee to take immediate steps to manage cashflow and improve profitability. This also allows the business to provide up-to-date financial information to the bank, which can then in turn fund the business and any working capital or plant and equipment requirements on the strength of the financial reporting. It’s worth noting that good quality financial information also supports a much higher price when selling the business.
Another advantage of good management systems is that they can bring together information that helps the franchisor negotiate favourable supply arrangements. This also applies to banking. Not everyone realises that if a large percentage of your turnover is through credit cards, then the merchant rate you pay will have a significant effect on your bottom line. This applies to other costs such as cash handling fees. Talk to your banker about a total package of business solutions which can include anything from insurance, electronic and on-line payments, credit cards and the ability to do direct debits, right through to personal banking packages.
use a specialist
By involving a franchise banker right from the start and working closely with a suitably-experienced accountant, franchisees can make sure that they have the best possible funding solutions in place both for buying their business and managing it on a day-to-day basis. Westpac has a team of franchise specialists based all around the country to help you find the funding solutions you need. If you’re thinking of buying a franchise, give them a call.
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.
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