FCA tells what franchises need

Understanding what a bank is looking for when accrediting a franchisor was a topic covered at the Franchise Council of Australia ’s Financing the Franchise Industry roundtable event in Sydney.

ANZ discussed what franchisees need to do in terms of homework before establishing a franchise, Westpac focused on the loan application process, while Matt Corkin from BankWest addressed the franchise system accreditation process.

“Each bank works across different criteria and with a different package. At BankWest our aim is to provide a valuable and relevant service to the franchise sector – funding franchisees against the value of their business and while doing this, mitigating the risk to the bank in the event of default by the franchisee,” Corkin said.

In assessing a potential franchisor, he explained that BankWest uses three key criteria to vet the suitability of a system for accreditation:

1. Market experience in years

2. Number of sites trading for 12 months

3. Capital cost of a Greenfield site.

“Ideally a franchisor will have had three to five years market experience. This benchmark gives us an idea that they have developed a model and an infrastructure to be able to support a company-owned or franchised network,” he said.

The next criteria relates to the number of sites trading for 12 months. By lending to franchisees, the bank spreads the risk of default between individual sites, providing gearing secured against the franchise for existing and Greenfield sites. To understand the performance of the group, between 15 and 20 sites (either company-owned or franchised) operating for 12 months or more, are required to assess the merits of the business and how well it is actually trading.

BankWest lends between 50 and 70 percent of the value of an existing or Greenfield site. According to Corkin, statistical research confirms the reduced risk of lending to the franchise sector secured against the value of an actual franchised business, compared to a standard small business. The reason is that there is a proven track record and a model that reduces the risk in lending to those franchisees.

“Ideally we are seeking franchisees that require a capital cost for a Greenfield site of between $150,000-$250,000. However, we are currently considering lending to franchise systems with requirements of less than $100,000,” he said.

What constitutes accreditation?

“Assuming a franchisor meets the criteria, we then look at franchisee profitability. We’re not lending to the franchisor, we’re establishing a process that involves lending and spreading the risk between all franchisees. We focus on 12-month sales for all sites, including the average ratios for an ideal franchise. A ROI calculated against the average cost of a Greenfield site can be ascertained to meet internal benchmarks,” Corkin said.

Litigation

“Litigation against the franchisor enables the bank to understand issues that have been brought against the system and how they were resolved under the Code of Conduct,” he said. “Litigation is a risk to the bank as it can trigger default for a franchisee. However, by understanding the circumstances, we can mitigate the risk as part of the accreditation.”

Franchise recruitment

According to Corkin, franchise recruitment can affect the operation of the business and therefore its value. Selection criteria will vary between emerging and mature systems that have an established network of franchisees. BankWest provides gearing of up to 70 percent secured against the franchise with a franchisee required to contribute a minimum of 30 percent equity.

Site selection

Systems that place sites into the market to increase branding are at an increased risk of default compared to systems that use statistical data, comparable locations and demographics for site selection, he maintained.

Conclusions

“Franchisor accreditations provided by banks ensure an avenue of growth for a system by lending to franchisees through a consistent model,” Corkin summarised. “The goal of the bank is to provide lending to franchisees of accredited systems, spreading the risk between individual sites, rather than the franchisor as one entity.

“The challenge for all banks is to identify opportunities within the sector, mitigate risk by completing the accreditation process, and proactively supply a service and package that meets the franchisee’s specific needs.

“The challenge for the franchise sector is to increase the number of systems accredited through educating franchisors on the benefits, while lobbying and educating the banks of the risk in lending to the sector.”

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