last updated 07/12/2010
Westpac - Facts About Franchise Funding
last updated 07/12/2010
Westpac’s franchise team get numerous questions from potential franchisees, mostly regarding the same concerns. The following are among the most common. The answers given may suggest further questions about funding the specific franchise you are interested in.
Q Why is a franchise more attractive for someone wanting to go into a new business from a funding perspective?
The strong systems and brand developed by the better-known franchise systems tend to lower the business risk considerably. As a result, a bank with a specialist franchise unit like Westpac is prepared to lend against the new franchised business itself, based on the record of the franchise system and all the other existing franchisees.
In practice, this means that potential franchisees need less of their own money and can secure part of the investment against the assets and future cash flow of the business. As a result, you may be able to afford a much larger business than you were originally contemplating. This is an important consideration, especially for immigrants who do not know the business environment and do not have a credit history in New Zealand.
Q How much can I borrow?
The question should not be how much can you borrow, but rather how much do you need to borrow? Your aim should be to borrow the minimum necessary in the most cost-effective way, while not leaving yourself short of the finance necessary to fund working capital.
The basic question is: how much can the business afford to repay (debt servicing in banker-speak) while still allowing you a decent living? You must take advice from an experienced accountant to work this out, and will need to include any tax implications in making the calculations.
Your bank will look at how much money or equity you are prepared to put in yourself, the security offered, your financial record and proven business acumen or other factors if applicable. In certain exceptional cases, with well-known proven systems or where the equipment or stock lends itself to this approach, the bank may also do some debenture lending or cash flow lending. This can reduce the total security required. Because of the many variables involved, this will be judged on a case-by-case basis.
You may also need more than a simple loan. The right mix of finance may include: short-term working capital (e.g., an overdraft facility); medium-term business finance (eg. a term loan); long-term finance or equipment leasing. The bank would look at the term of your franchise agreement; the debt servicing capabilities of the business and the particular needs of the industry in determining the best mix of financing. In some cases, leasing vehicles or specialist equipment can reduce the actual initial borrowing required.
With proven systems the perceived risks are lower and the loan requirements are often more relaxed. This is another reason for you to expect that your business banker should have knowledge about the franchise systems in which you are interested.
The vital steps are: determine how much you need; how much you can afford; and involve your banker in the decision-making process on the right amount and mix of the financial solution that is required. If you familiarise yourself in advance with the process and information required to obtain finance, it will save a lot of time and effort. It will also help you to ask the right questions when buying a business, and put you in a much better position for making a decision when the time comes.
Q If necessary, can I have 100% financing?
Yes you can, subject to certain requirements. Your bank will look at how much money or equity (eg. the value of your house or other investments) you are prepared to put in yourself as secured lending – usually some 50% will be required. The balance will be loaned against the business itself if the strength of the brand justifies it. Before agreeing to such an arrangement, the bank will consider the security offered, your financial record and proven business acumen as well as other factors if applicable.
Note that the mix of secured and unsecured lending as well as the term of the finance can dramatically influence the monthly repayments. The business lending (typically a business term loan of three to five years) would use a GSA – General Security Agreement – and would be more expensive than the fully secured part of the lending. How much more costly would depend on the risk. Vehicles or equipment can also be purchased through equipment finance or leased, lowering the initial capital requirement further, but this tends to be more expensive again.
The biggest question of 100% finance (or any other level) is, ‘Can the business can afford it?’ Your franchise banker can offer you different options to suit your requirements. Under-capitalisation is one of the greatest causes of business failure. Even the best business can be brought down if it is struggling under the burden of too much borrowing, which is why it pays to be careful. On the other hand, wisely structured borrowing can enable you to take up that opportunity, repay the loan and enjoy the income you earn. The important things to remember are:
1. The loan should be capable of being repaid within the term of the franchise agreement, or if not this should be taken into account when selling.
2. Payments must be affordable.
3. Get the right mix of short and long term funding. Discuss your future business plans with your franchise banker. If you want to open a second franchise in 18 months, the funding structure can be very different to make it possible.
4. Always take appropriate legal and financial advice.
Q When looking at funding, is it better to buy an existing franchise with a proven financial history than set up a new outlet from the same system?
From a funding perspective it may be easier to find finance for an existing profitable business, especially if it is an unknown or new brand. Buying an established business would lower your risk but you also would be paying more for it in the form of goodwill. This lowers the return on investment. The key is profitability though; if it does not have proven financial results, you may be buying someone else’s problems.
A new business can be more difficult to fund unless it comes from a proven franchise system. Benefits to offset the higher risk of a new business include: more choice of locations; opportunity for significant capital growth; getting a new franchise term and/or lease; having totally new equipment and fit-out. You also do not pay goodwill, meaning the return on investment could be higher.
These are just a few of the issues that potential franchisees typically ask about. You should not hesitate to ask your accountant, banker and franchisor further questions about any concerns you have regarding funding and expected financial returns. After all, your future and livelihood depends on getting the information to help you make the right decision.
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