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Finance: a tighter grip?

Sarah Stowe

Major financial institutions are an integral element of the franchising mix – without funding neither franchisee nor franchisor can develop, and for most franchisees, the starting point of investing in a franchise system is a bank loan. Anecdotes from franchisors indicate that the banks have become tougher in their approach to lending – a reflection of the global financial crisis and a reluctance to commit money to any business with a less than sure chance of success. The banks want a return on their investment. So where does this leave the prospective franchisee needing a financial boost to set up their own business?

There has been media and industry speculation that banks are no longer open for business for franchise finance which is not the case in my experience as we are lending to the sector in record numbers and employing more bankers to continue this growth, says Darren McAuliffe, national manager franchise banking with NAB.

There has been no credit rationing on our behalf; we have loaned over $20 billion to SMEs this year.

ANZ general manager commercial products, Fred Ohlsson, confirms the bank is open for business to franchisees and franchisors.

When we’re evaluating a business for funding or expansion, we are especially interested in the experience of the operator and their trading history, the catchment of the business, appropriate information systems, and a demonstrable history of profitable trading.

Banks play a fundamental role for franchisors and franchisees: well established and proven systems gain accreditation with a bank, in theory easing the process for incoming franchisees to raise funds – the higher the accreditation the greater the loan percentage.

Rod Nuttall explains the Commonwealth Bank’s current approach to franchising. We see the franchising sector as quite resilient, particularly in food and services as provided unemployment levels remain stable people are maintaining their level of living standards day to day. We have a dedicated team so we have specialist managers and are increasing these all the time.

Unless the performance has been catastrophic, Nuttall says the bank has not dropped any accreditations. If we have concerns we discuss these concerns with franchisors. This may result in lowering the accreditation level ie the loan valuation ratio (LVR) or removing accreditation. But there have not been any accreditations removed for over 12 months.

We deal closely with franchisors and are actually looking to perhaps double our accreditations. We are finalising a new accreditation model that is faster.

Enhancing the accreditation model to be more accurate follows four simple precepts: firstly, performance to market, how is the franchise going, the number of transfers and cessations? Secondly, what’s the franchisor’s financial position? A third indicator is franchisee performance including satisfaction that comes from the franchisor’s ability to help them in areas such as bulk buying arrangements and better rent negotiations. Finally the bank reviews the system’s portfolio – how many franchisees have exited because they’re not financial viable?

We do have a weighting on each criteria, and if someone is weak on one, they’re likely to struggle to reach maximum LVR, admits Nuttall.

Darryn McAuliffe, says the situation at NAB is comparable. We are familiar with and have financed many franchisees into most major systems. NAB has not formally withdrawn accreditation of any systems in the last 18 months however there are several that are being closely monitored.

The NAB generally reviews formal accreditations on an annual basis and as part of this process will increase or decrease lending ratios and conditions based on the system’s track record and apparent risk profile.

Like the CBA, NAB is increasing its accreditation and working at fine-tuning the process. In particular we are working with many systems to put in place more standardised arrangements to promote a more efficient and predictable process flow with each transaction, reveals McAuliffe.

Both deny the existence of a ceiling to the number of systems accredited but highlight the role of prudent risk management. At the NAB ceilings are considered internally and communicated confidentially to franchisors on a case by case basis, says McAuliffe.

Banks need to have a rigorous credit assessment process for all sectors and industries within business banking, he reminds, not unlike franchisors when reviewing prospective franchisees.

In his eyes good quality, well-managed and tightly run businesses should continue to enjoy financing support. Lending capacity is primarily determined by the risk profile of the business.

Julie Rynski, Bankwest head of business and private banking, and business and customer services, says I think competition is pretty tough for banks, and IÍm very keen to expand. The accredited process is now a lot easier.

I’d love to increase accreditation; the only slow down is when franchisors don’t supply the latest financial data or the business is not going well.

She suggest a number of businesses who decide to franchise don’t really have the infrastructure to support this. But there is no doubt in her mind that franchising is a growing market. I see franchising as having enormous growth potential, particularly for well established systems with very good infrastructure.

Nuttall admits the CBA is better educated about what franchising is like today. If a company was corporate, rather than fully franchised, it might show a $100 million group turnover as opposed to the same group under a fully franchised model illustrating the $6m that comes from franchising royalties.

Because the offering is different to a corporate proposition franchise systems with a large network, buying arrangements, and employees, are taken into consideration. We look at the sustainability of cash flow. We’ve lent money over the last two to three years to franchisor groups though their proven cash flow.

It’s undoubtedly harder to evaluate a new franchise system; tenure is testament to business success. But franchisors will be viewed similar to any commercial funding; the bank considers the business plans and how will they will be achieved, what the contingencies are, cash flow to repay the loan, and what equity there is.

A young business without accreditation can still be a good business. Prudent lenders are still looking to provide credit to new and existing customers, assures McAuliffe. A common misconception is banks only want to deal with larger systems. Our franchise bankers work with systems of all sizes to provide financial solutions for their needs which differ greatly.

Developing an understanding of the franchise system is one of the most important steps in the banking process and we do this for all sizes of systems and for accredited and non-accredited systems.

A bank will lend most at the cheapest level when it is confident about investment, says Nuttall. Pricing has always been about matching risk and return in the appropriate balance. We’re trying to be conservative and commercial at the same time.