Financing a franchise: The BankWest Top 10

An integral part of becoming a business owner is obviously evaluating the financing options available to you. Buying a franchise is a lower risk option financially to the standard small business due to the proven track record and support of the franchisor. Banks acknowledge the risk in lending to specific systems by providing lending packages of up to 70 percent of the value of a new or existing site, providing prospective franchisees finance outside of the equity in the family home.

Following are the ‘Top 10’ issues a franchisee needs to consider when financing a franchised business:

1. Choose a system. Is it accredited with a financial institution?

2. New or existing site? Location is the key.

3. Establishment cost of the franchise. What equity am I contributing?

4. Homework completed. Speak to the franchisor and franchisees.

5. Create a business plan and cash flow forecast. Collate historical financial data.

6. Speak to a bank that has a specialist franchise unit. Apply for finance.

7. Conditional approval. Follow up conditions early and understand timeframes (bank and franchisor).

8. Ensure letter of offer and security documents are in the correct names and executed in the correct format.

9. Seek independent legal and financial advice from specialist advisers to the sector.

10. Make franchisee equity contribution available for settlement.

Choose a system – is it accredited with a financial institution?

Banks accredit systems with a proven track record, providing lending packages against the value of the franchise. Each bank has different parameters, providing competitive packages to applicants. In selecting a system of choice, the franchisee will need to consider how they are funding the purchase and whether the system is accredited with a bank.

If the system is not accredited with a financial institution, it does not mean the system is not a viable alternative. It may, however, mean that the system is in a different life cycle outside of the parameters set by each bank.

If the system is accredited with a financial institution expect to receive lending secured against the franchise with agreed parameters introduced by a specialist manager who understands the system and franchising.

New or existing site?

Do you purchase an existing business with historical trading figures, or establish a new site based on potential and projections?

The value of a retail franchise is generally based on EBIT (earnings before interest and tax) by a multiple of three to four. An existing site with historical trading figures is usually purchased in excess of a new site as the purchase price includes a goodwill value payable to the vendor. Comfort is provided to the purchaser as they can confirm historical trading figures over a period of time to ensure the business is viable.

A new site may appeal to a franchisee as goodwill is not payable, given that the site has not traded. A set cost is agreed to establish the store between the franchisor and franchisee regardless of forecast trading figures prepared by the franchisee. Therefore, a new site has the potential to increase in value over 12 months based on the performance of the store, providing the franchisee with increased value and available equity (goodwill).

The downside to a new site is that trading figures are forecasted and therefore may not achieve the benchmarks set for 12 to 18 months, if ever, thereby reducing the value of the store.

Establishment cost of the franchise – what equity am I contributing?

Minimum equity contribution is a key component in assessing whether a franchisee meets the first requirement. If a system is accredited with 50 percent gearing available, a minimum of 50 percent of the establishment cost/purchase price is to be contributed by the franchisee. The contribution can be in the form of cash or equity in a property, with equity calculated as:

Value of property: $300,000

At 80 percent of value: $240,000

Less home loan: $100,000

Equity available: $140,000

In this instance, $140,000 is available to the franchisee as equity contribution for the establishment or purchase of a franchise.

Using the example in the table, the franchisee is able to purchase/establish a franchise for $280,000 based on equity contribution of $140,000 and 50 percent gearing against the franchise for a further $140,000.

Homework completed – speak to the franchisor and franchisees

The best way to understand a franchise system is to complete your own due diligence and speak to as many representatives of the franchisor, as well as a number of franchisees, as you can. Some areas in which to seek insight include:

• Support offered by the franchisor

• Communication between franchisees and franchisor

• Ease of systems within the group

• Level of training provided

• Experiences in establishing a new site.

Insight from franchisees is invaluable in gauging their relationship with the franchisor, as well as gaining tips on running the franchise and key benchmarks within the system. It is recommended that a minimum of five franchisees are spoken to so that a true perspective is obtained.

Information received from existing franchisees will also assist in preparing a cashflow forecast and business plan for your own store.

Create a business plan and cash flow forecast – collate historical financial data

To create a business plan and cash flow forecast it is necessary to understand site demographics, whether it is in a shopping centre or strip location, rent costs, lease terms, potential traffic and parking facilities, etc.

Once a site is available, a cash flow forecast can be developed using key financial ratios for the system and forecast sales based on anticipated traffic past the store.

Cash flows and business plans received by banks can vary quite dramatically in terms of detail, due to the individuals preparing each item. To assist the approval process, the following points should be considered:

1. Cash flow forecast should be prepared in a profit and loss format on a monthly basis with a total calculating a 12-month period.

2. Assumptions used to prepare the cash flow should be included in the business plan to explain how the cash flow has been calculated. (Sales have been based on 1000 customers per week at an average spend of $3.)

- Cost of goods sold is 25 percent based on …

- Wages costs (excluding franchisees drawings), calculated at 27 percent based on five casuals and two permanent staff and one manager, …3. Business plan to include:

• Executive summary

• The company

• Products/services

• Industry analysis

• Market analysis

• Marketing strategy

• Management

• Implementation plan

• Financing

• Financial information

• Industry specific data.

Speak to a bank that has a specialist franchise unit – apply for finance

Key lenders to the franchise sector have established specialist franchise divisions in order to service franchisees throughout Australia. The benefits of seeking finance through a specialist lender include:

1. Understanding of the franchise sector

2. Knowledge of the accredited franchise system

3. Consistent answers to franchisees.

With an understanding of the marketplace and system, banks are able to provide an answer within five working days as a result of pre-existing information. Especially in the case of a new site where no historical financials are held, a judgement call is required on a cash flow forecast prepared by a franchisee.

Each bank has a team/specialist in each state to cater to the needs of franchisees in metropolitan and regional areas.

To submit an application for finance the following information is sought:

• Business plan and cash flow forecast for three years (new site)

• Two years historical trading figures for an existing site

• Year-to-date management figures for an existing site

• Two years personal tax returns for each director/guarantor

• Certificate of incorporation

• Trust deed (if applicable)

• Franchise term – i.e. 10 years

• Lease term – i.e. five years with five year option.

Conditional approval – follow up conditions early and understand timeframes

As mentioned, within five working days a bank can provide an indicative answer for finance that will be conditional. Typical conditions that need to be met prior to issuing a letter of offer and security documents include:

1. Satisfactory valuation over the residential/commercial property being used as security

2. Satisfactory valuation over the franchised business (existing site)

3. Contract of sale for the franchised business (existing site)

4. Executed franchise agreement

5. Executed head-lease/sub-lease and/or licence of the premises

6. Confirmed costing for the establishment of a new site

7. Independent legal and financial advice.

It is important that the applicant understands the conditions listed on the indicative approval, as each can affect the timeframe to complete the settlement of an existing site or the construction of a new site. In times of stress understanding the timeframes of the franchisor and bank can make the difference between trading and earning income or paying expenses with no income while waiting for a condition to be met.

Of course, some conditions will be out of the franchisee’s control, and as such open communication between the franchisor, franchisee and bank is required to ensure all objectives are met.

Ensure letter of offer and security documents are in the correct names and executed in the correct format

While a bank will endeavour to ensure all documents are issued in the correct names, mistakes do happen, and it is important that the franchisee check all documents issued to ensure that all individual, company and trust details are correct. If an error is highlighted, some documents can be changed and initialled to confirm the changes (confirm with your bank representative). A common error is that a spouse’s maiden and married name are used simultaneously, with a marriage certificate required to legally confirm they are one and the same person. In this instance it is best to highlight which name is to be used on all documentation prior to issuing legal contracts.

Other key points to note are:

1. Franchise agreements and lease documents in the applicant’s name should be the same as loan documents supplied by the bank

2. Contracts of sale for the purchase of an existing site should have the same names as the franchise agreement and loan documents

3. Applicants using their property as security should have the same details as the loan documents.

To simplify the mountain of paperwork supplied by a bank, ‘sign here’ stickers are placed in the correct execution places for ease of reference. Double-check all execution places have been completed prior to returning documents to the bank. An extra five minutes checking documents could save a week to re-execute documents ready for settlement.

Seek independent legal and financial advice from specialist advisers

As a new franchisee to a system and a first-time business borrower with a bank, most banks will request that a franchisee seek independent legal and financial advice to confirm that they understand their liability. The cost of seeking advice is borne by the franchisee, therefore it is important to obtain the right advice at the right cost. Often franchisees pay a solicitor/accountant to learn about franchising by paying an hourly rate in excess of the advice required.

The key is to seek referrals to specialists within the sector that truly understand franchising. A bank can provide an advocate list of key specialists, however there are a number of other avenues that you might choose to explore, including the franchisor, Franchise Council of Australia and, of course, advertisers in Franchising magazine.

Whatever the case, ensure that you seek advice from a specialist as it will save money in the long run.

Make franchisee equity contribution available for settlement

As outlined in ‘Establishment cost of the franchise – what equity am I contributing?’, prior to settlement the franchisee’s equity contribution is required to ensure that settlement can be effected. If equity is provided through a residential property allow time for a refinance to occur between banks (approximately two weeks).

If cash is being contributed, ensure it is available in a nominated account to allow for settlement to be completed with no shortfall in funding. Too often the franchisee under-capitalises funding required, with the shortfall highlighted the day of settlement. Make sure there are sufficient funds to cover all costs, including bank fees, legal/accounting fees and working capital.

Conclusion

Buying a business can be particularly stressful, so understanding all requirements, including timeframes, will assist in streamlining the process through to settlement.

Ensure that specialists are consulted, whether they are banks, lawyers, accountants or franchise recruitment consultants, so that you do not pay a professional for time to learn about the sector.

Above all, try and keep it simple and communicate regularly with the bank and franchisor to ensure all are of the same understanding.

The Franchise Council of Australia is a not for profit membership organisation that is the peak body representing the franchising sector in Australia.

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