Business mentor: Borrowing for a franchise

Q. I'm looking at buying a franchise and need to figure out how best to fund it. My previous experience with getting a bank to fund me into business was not very successful. Any ideas?

A. Daniel Cloete, of the Westpac franchise team, replies:

Small businesses in general are high-risk, making it difficult for traditional banks to do unsecured lending in this market.

The good news is that because the strong systems and brand of the better-known franchises tend to lower the business risk considerably, some banks have been able to take a position in this market. This means a bank with a specialist franchise unit is prepared to lend against the new franchised business, based on the record of the franchise system and all the other existing franchisees.

In practice it means that potential franchisees would need less of their own money and can secure part of the investment against the assets and future cashflow of the business.

This does not mean that someone can go into a business with no investment of their own, and almost no franchisers would accept a franchisee who is not willing or able to make a significant contribution in cash, equity or other investment. Banks would take the same position, as their interest and the interest of the franchisee would be very much the same, at least for the term of the franchise.

In the case of this specific question, one would need to look at getting some other form of security, like third-party security, or use asset finance, depending on the type of franchise. But in most cases some form of equity investment would still be required.

How much money can I 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, say, working capital.

The basic question is: how much can the business afford to repay while still allowing you a decent living? You must take advice from an experienced accountant to work this out, and should include any tax implications in making the calculations.

Your bank will look at how much money or equity you are prepared to put in (about 50 per cent is normally required but it can vary), the security offered, your financial record and proven business acumen, or other factors if applicable.

In exceptional cases, with well-known, proven systems or where the equipment or stock lend themselves to this approach, the bank may also do some debenture lending or cashflow lending. This can reduce the total security required.

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 (e.g. 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. Sometimes leasing vehicles or specialist equipment can reduce the initial borrowing.

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 know 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 on the right amount and mix of finance required.

If you familiarise yourself beforehand with the process and information required in obtaining finance, it will save 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.

* Daniel Cloete is the national franchising manager for Westpac. Email: franchising@westpac.co.nz. Tel: 0800 177-007.

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