How to work out your budget when you buy a franchise

Sarah Stowe

Like any other business, being undercapitalised and having excess debt can be disastrous for a franchise. At the same time, it is not always advisable to put too much of your own money into a franchise so it’s important to get the right balance. There are two key activities you should undertake before deciding how much you can afford to fund your business purchase.

1. Develop a statement of net worth by listing your assets and liabilities.

2. Talk to an expert who can give you an idea of how the numbers add up: what your chosen franchise will cost to setup and run; when you can expect to turn a profit including determining your break-even costs; and how much you can expect to turnover. At this stage a return on investment analysis should be undertaken so that you can make an informed decision on whether the return is acceptable compared to other investments.

Determining the most appropriate mix of debt and equity to buy a franchise is largely based on an owner’s personal financial circumstances and their appetite for risk. If we assume your lender requires a 20 percent deposit, the total amount you can borrow could be limited accordingly.

If your appetite for risk is higher, then you may wish to borrow more. Some banks will lend up to 80 percent of the value of your home, for example. For the 20 percent of franchises that are accredited with Australian banks, you may be able to borrow more using the franchise itself as security.

Regardless of how much you borrow, it is important to remember that it may be some time before the franchise begins turning a profit, which means you may not be earning any money for the first few months of operating. It is vital to take this into consideration to ensure you can cover your living expenses in the meantime. If you have another source of income then the need to minimise risk may not be so great. If the franchise is your only source of income, then it is advisable to preserve as much of your net worth as possible.

Once you know how much you are prepared to invest and borrow to secure a franchise, the next step is to understand the complete costs of the franchise including “get in”, royalty and advertising, operating cost structure and “get out”.

What costs will you need to finance?

Costs can include legal fees, the initial franchise fee, bank fees and ongoing fees as well as working capital. It is also important to consider the tax implications of the purchase and how best to structure various components of the acquisition such as plant and equipment, fit-out etc.

Elements that can affect the cost of the franchise include the type of industry, whether premises and equipment are required, whether additional staff are required and so on.

Mobile, personal services and home-based franchises tend to be the most affordable, while retail and food franchises are more expensive.

A well-established, successful franchise will charge higher fees but this is likely to be offset by the potential revenue. At any rate you need to look for value for money and ascertain the support level from the franchisor in terms of in field support, marketing and sales support and general business advice.

A general rule of thumb is that the business should provide earnings before interest and tax (EBIT) in the vicinity of 25-30 per cent of the purchase price. EBIT is calculated after providing a nominal salary for you as the owner. This can be flexible depending on the type of business and potential for growth.

Do your own research

A word of warning: do your own financial analysis or get a trusted financial advisor to do so rather than relying on the figures presented by the current owner or franchisor. While those figures may not be incorrect, they may be based on best-case scenario data. While it is important to purchase a franchise that you are passionate about, if the numbers do not stack up then you should be prepared to walk away.

Do your own due diligence and talk to a wide cross section of franchisees in different locations to get a better feel for any issues you need to beware or potential areas of concern.

  • Ready to seek finance? Check these eight steps first.