How do I fund, or raise finance, for a franchise?

It is a big step from deciding to start a finance to actually opening your doors for business. For many, one of the biggest hurdles is approaching the bank for finance.

Of course, there is a lot of work to do before you will be ready to part with any money, you will need to research your chosen franchise, making sure that it is the right one for you and that you are fully aware of what is involved.

You will need to ensure that you can afford to purchase the franchise you are interested in, and set up your new business.

The first step is to establish how much money you can invest in the business – what can you afford to invest? Have you got savings, can your family help?

Hopefully this section will give you some guidelines to work to in order to be able to approach a Bank for finance in a confident way, with an awareness of the type of questions likely to be asked.

Approaching banks for finance

Banks have learnt that it can be safer to lend to franchisees of well-structured ethical franchise systems. The track record of the franchisor is most important.

For an established franchise, most of the major banks will lend up to 70% of the start up costs, for new franchises the figure will probably be around 50%. With this in mind,

  • How much will you be able to borrow? Prepare a full list of your personal expenditure mortgage, hire purchase, household bills, and so on. This will show how much money you will need to take out of the business in order to live.
  • What security can you give to back up your loan? You might have a life policy with some value, or have equity in your home.
  • Start preparing your business plan – this is a vital document to obtain finance from the bank. Your chosen franchiser will often help you with this.

As part of your business plan, you will need to prepare cash flow forecasts for the first couple of years of the business. Your franchiser will help, but you need to be sure that you understand the figures, what are they based on, how much do you need to turnover in order to break even?

Some banks use the following approach to assess your request for finance.

PERSON – Who are they lending the money to?

The bank will carry out a full review of your background and reliability, your training, qualifications, and track record, financial resources, suitability to run the business.

A franchiser will also look at this to ensure that you are a suitable franchisee.

AMOUNT – How much are you looking to borrow?

Banks will normally expect the franchisee to contribute at least 30% of the total cost of the franchise. This contribution should come from your own resources

Apart from the actual amount the bank will also look at

  • the purpose for which the money is going to be used and
  • it’s effect on your business
  • is there sufficient demand for your product or service (the -fact that you are going to be investing in a tried and tested franchise format helps here)
  • how will the money borrowed benefit the business?
  • What type of finance are you looking for overdraft, loan or a package of financial services?
  • how much are you investing in the business? Normally you are expected to contribute towards the total start up costs from your own resources
  • have you asked for the right amount; is it too much or too little?

Your franchiser will normally help with setting out details of start up funds required and help with the preparation of cash flow forecasts.

REPAYMENT – how do you intend to pay back the money?

It is not in any one’s interest to lend you money unless you can repay it.

  • Where is repayment coming from
  • Future trading profits after allowing for all your other financial commitments or from the sale of an asset?
  • What assumptions have been made in the cash flow forecast?
  • What levels of sales are needed to break-even and are they achievable?
  • Is there a contingency plan for any setbacks?

SECURITY – how much risk is involved?

The bank must assess the risk of lending to you and decide whether security is required. This will depend on their evaluation of your business as a whole

  • the prime source of repayment will be cash generated by your business and no amount of security will ever be acceptable if they feel that your business is not viable.
  • The last thing they want to do is realise any security – they would much rather see a successful business continuing to trade.

They recommend that you take independent advice from your solicitor before you provide security.

If no security is available, they may be able to consider finance under the Government’s Enterprise Finance Guarantee, if your business is eligible. This is a Government backed scheme to guarantee 75% of borrowing (for both businesses under and over 2 years established) where security is not available and where that lack of security is the only bar to a bank lending the money.

INTEREST & FEES – how is it calculated?

When the bank set an interest rate they take into account a number of factors including your stake in the business, security deposited and their evaluation of the risk involved. There are some special finance schemes for some of the larger, well-established franchisors. They may also charge a fee to cover the costs of setting up new borrowing and completing the security arrangements.

Forms of finance

The provision of finance can be in several different forms. Loan accounts are most often used for the purchase of assets e.g. property where the loan will run for a longer period or a vehicle purchase where the term of the loan will be much shorter to reflect the rapid depreciation of the asset. Fixed interest rates are often available.

An alternative method of funding working capital is invoice finance, which involves raising finance using your debtor book. The advantage of this is that cash flow is directly linked to business expansion. This method is not suitable for all businesses and your bank will be able to advise you.

Another method of finance to consider is asset finance to fund the purchase of equipment for the business. This can help ease cash flow by spreading repayments over a period of time instead of making a one off investment.

As a potential franchisee, you are however in a better position than a self-employed person setting up a business from scratch. You have the backing of a proven business format and details of how similar franchisees operate to show the bank.

There are many company’s in South Africa that help entrepreneurs obtain finance for a franchise, one of them is Franchise Finance a loan origination agency in the highly specialised field of franchise finance that you may consider for financial assistance in the franchise business.