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Aug, 01 2007

Financing THE FRANCHISE

FINDING the right franchise is no easy feat. It can take huge amount of time and effort to research various industry sectors and the variety of franchise opportunities that are available.

FINDING the right franchise is no easy feat. It can take huge amount of time and effort to research various industry sectors and the variety of franchise opportunities that are available. But the hard work is worth it. As any franchisor will advise you, they would not award a licence to the first hopeful candidate that walks through the door and will be looking out for evidence that you have the skills, experience and attributes to take on the licence and make it a success.

It is equally important that you as the franchisee are also selective. As with any commitment, it is vital to make sure it is right for you before you take the plunge. Once you have made the final decision, there are many issues you will need to consider and one of the most important of these is how you will finance the franchise.

When thinking about financing your franchise, your first source should be your savings, family and friends, partners or investors. Regardless of the type of financing you seek, you will still probably be expected to invest 20 to 30 per cent of the total costs. Also, to support yourself during the start-up phase, you have to set aside enough money to sustain you and your family for at least one year.

The major costs associated with starting a franchise include:

Franchise and training fees

Equipment fees

Software and licence fees

Location costs

Miscellaneous (advertising, utilities, rent, etc.)

Entrepreneurs in search of finances need to address the following five areas:

Sector: Decide on the type of franchise and franchise sector before you start investigating finance options. Get a loan application from your bank, start identifying the characteristics of the ideal business for you.

Plan: Prepare a business plan that describes your Five Cs:

Character (reputation and honesty)

Capacity (business acumen and experience)

Cash flow/capital (ability to meet debt-service payments)

Collateral (access to assets that can be liquidated in the event of a default)

Credit history (to judge your ability to consistently pay for the loan).

Research: There are many sources of capital, so research a couple of options to see what makes the most sense for you. You will need to invest about 1/3rd of the total project cost from your own resources and can look to a bank to loan the remaining two-thirds of the total project cost.

Working capital: The reason why businesses fail is undercapitalisation or inadequate cash flow. Prepare for this by having sufficient working capital.

Loan application: Consult with the franchisor as he is in the process of expanding his operation and will help you with the loan application process. Many banks are willing to finance franchised businesses, especially if you are willing to pursue a loan guarantee through the franchisor.

Acquiring funds

There are many different ways to finance a franchised business but no application for financial support is possible without a robust business plan setting out your business idea, objectives, the background and abilities of the business owners, financial requirements and projections. Tax returns, account balances, debt payments and loan amounts are all fair game and you should have them together in a comprehensible form when you apply for financing. Lenders will require all these documents to finance your franchise business. The length and complexity of the business plan may vary according to the amount of investment or finance that you are looking for. To give yourself the best shot at securing the funding you need, you will need to take responsibility for writing the plan and you should be able to confidently present it to the lender.

Here are some financing options that you can choose from:

Family and friends

Of course, for some there will be the option of borrowing from family and friends. A clear advantage of doing this is the flexibility it will give you to repay, but it is still important that the terms of the agreement are set out clearly from the start. While borrowing from a relative or friend may mean you have more flexibility, it can also leave more scope for things to go wrong. Arguments over loans are not uncommon, so to avoid things turning sour, you should not enter into any agreement lightly.

Franchisor financing

One of the advantages of buying a franchise is that nearly all franchisors offer some form of financing. What and how much they are willing to finance varies from one franchisor to another. However, if you intend to pursue franchisor financing, be aware of two things:

The process for obtaining finances through a franchisor is going to be very similar to the process you would go through with any other lender. If you are looking for easy financing, you are probably not going to find it through your franchisor.

The franchisor will most likely only lend you a portion of the funds you need to get started. This amount can range anywhere from 10 per cent to 75 per cent, hardly ever will a franchisor finance you 100 per cent of the needed investment.

Banks

Franchisees have a lot in their favour when approaching banks for funds. A franchise is by its nature, a business that has already proved a success. The help given to franchisees in the way of training and development by the franchisor, means there is constant support for the business from the franchisor. And the fact that the franchisee will be following a tried and tested business system means that the business is expected to grow faster than a stand alone business and is less likely to fail.

As long as franchisees can provide a well constructed business plan with adequate personal investment to set up the business and security to cover the financial request, the banks should be willing to provide funding. Typically a franchisee will need to invest between 30 to 50 per cent of the start up costs and the request for funding will be subject to full credit assessment from the bank.

Banks will also be looking for evidence that you as the franchisee will be able to manage the repayments and the terms of finance, on which they agree to lend you the money. Remember it is a competitive market and banks are always looking out for strong franchised businesses.

There are several types of financing franchisees might want to consider. Short term working capital is usually financed by an overdraft facility, which provides flexibility and only accrues interest when the facility is actually being used. There is usually an annual arrangement fee for setting up an overdraft limit.

If you are looking for longer term arrangements to finance any assets of the business, a business loan is usually best. It will give you a structured repayment programme and the option of setting interest rates at the outset, to give you the security of knowing how much you will need to repay each month. Banks will usually charge a one time processing fee at the start of the loan.

Asset financing companies

Sometimes, assets for the business such as vehicles, machinery and computer equipments can be purchased through asset finance companies. Usually the asset financing company will retain ownership of the asset until the full outstanding amount has been settled. Repayments are usually made monthly over an agreed term from the outset.

Other financing options

Another form of financing can be found through investors and acquaintances who believe in you and your ability to make a franchise work. Some potential franchisees will be able to fund their purchase using their own resources, for example their own savings. Most people however, will need to find some form of financial support and advice and more often than not they will turn to a bank.

Advisory

Whichever route you choose or advice you take to raise finances for your franchise, it is important that you remember the responsibility that comes with borrowing money. Hopefully, you would not encounter too many problems, but if you do experience difficulties, the most sensible course of action is to take as much advice from your financial services provider as possible on the various options open to you, before you make any decisions on how you can raise finances for your franchise.

The most important thing when considering purchasing a franchise is research. Investigate the franchisor's training programs, ongoing operating support, and purchasing power (e.g. discounts on supplies and inventory). The most valuable source of information on any franchise system is existing franchisees. Talk to them to find out where they got their financing from.

Even though a franchisor might offer funding, you should still check out your other options. After all, your goal is to secure a loan with the best possible terms. Basically, you need money with the least amount of collateral, at the lowest interest rate and the best repayment terms. Those savvy in business financing often first try their friends and relatives before moving on to home mortgages, bank loans and other finance companies in that order.

The decision to open a franchise is one thing. Financing it is something else entirely. Unfortunately many potential franchisees make plans to open a franchise without giving any consideration to financing, even though financing is one of the major hurdles they need to cross before they sign on the dotted line and open their doors for business.

Choose a lender that specialises in franchise loans because they will be more responsive to your business needs. Beginning a new business is not an easy process. In fact, financing is one of the first things you should consider when determining whether or not to start a franchised business. Arm beforehand with the right information and knowledge, however, you can avoid the many pitfalls and go on to become a successful entrepreneur.

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