Funding a Franchise Business

In our winter issue, Westpac’s Daniel Cloete looked at Return on Investment. Now, he covers the funding aspects of buying a franchise and how the price of a business affects the ability to obtain funding.

How much money do I require? 

Franchise adverts can be very confusing because franchisors don’t all use the same assumptions. If the capital requirement is listed between $90,000 and $120,000, what’s included in this price? Does it include the franchise fee and, for new outlets, the fit-out? Does it include equipment, legal costs and accounting fees? Is this the total cost of your investment or does it only reflect the cash equity needed? 

How much can the business afford?

After getting a good idea of how much your new business is going to cost you initially, and the ongoing payments to the franchise system, the next question should not be ‘how much I can borrow?’ Rather, ‘how much can the business afford, while still delivering a decent living and return on investment?’ This is even more important when the economy is under pressure. Yes, this may present unique opportunities, but it can also increase the risks.

Do I truly understand the figures? 

Get professional advice, but understand the figures yourself. Ask your franchise accountant to assist with cash flow projections, which will help you understand what makes the business profitable, and the funding required.

The next questions should be directed at your current or proposed funding provider:

Is my current bank equipped to help?

Does your bank have the franchise system knowledge, benchmarking and strategic relationship with your chosen franchise system to deliver real added-value lending as well as transactional benefits?

Does my bank offer a franchise lending policy? 

This is, as opposed to a generalist business manager, normally requiring 100% security. You want your banker to add value with the initial lending, based on their knowledge of the business model and benchmarking. But also show ongoing commitment to the system beyond the initial lending. An example could be franchise-specific merchant payment solutions. 

Can you fund against future cash flow when setting up a franchise from a well-established franchise system? 

This could lower your equity requirement and mean you could afford a much larger business than setting up a standard small business. How much would be determined by the debt servicing ability of the business and the reputation, and business model, of the franchise system in question?

What is an appropriate term of the funding?

Normally, short-term funding would not be suitable to fund the business and would be more appropriate for working capital. Try to match the funding to the asset and consider when it needs to be replaced. In the case of a retail outlet, consider when the store will need a total refit.

How much working capital will be needed? 

This simply means the amount of cash you need to run the business effectively. It is used to pay bills such as wages, and sometimes to carry stock until the business generates income. Very few businesses can operate without working capital. 

What are my business’s day-to-day transactional needs? 

People tend to concentrate on the initial lending, but forget about the ongoing transactional banking needs that influence their bottom line. What products and services will you need in place to help you manage your cash inflows and outflows?

Rental or stock bonds? Ask early on. 

For premises-based businesses, a rental bond may be required. This could increase the capital needed from your side, so it is worth negotiating robustly. Some suppliers (or franchisors, if they pay for stock) may also require a stock bond. Performance bonds can also be required for some service-type businesses.

What are the funding structures, term and security options?

Remember, the lower the multiple you pay for the business (for example, the multiple of EBITDA profit – earnings before interest, taxes, depreciation and amortisation), the more debt the business can service. This may influence the possible funding structures, term, and security required. Talk to your accountant or banker about options.

One last point to consider is your personal finance needs... 

Does the business income need to support my home lending and personal lifestyle? If so, how much is needed?

These are only a few of the things to consider. 

Your banker and accountant will be able assist you with all factors involved, including offering different funding options, transactional solutions and suggesting optimum funding structures for your business.

To summarise, you may be paying a lot more for a franchise from an established brand with a good track record, but you also lower the risk and increase the chance of getting a profitable business with a sustainable business model. 

You still need to do a proper assessment, with the help of professionals. 

A franchise-friendly bank takes these factors into account, which may make it easier to obtain finance.

See this advertorial on page 22 of Franchise New Zealand magazine Year 33 Issue 3

Contact details for Westpac

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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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