Can you afford to buy a franchise?

By Sarah Stowe | 26 May 2016 View comments

How much can you spend on a franchise? You might have your sights set on a fast food chain but if the numbers don’t stack up, then you’re better looking at an option more suited to your budget.

A careful review of finances will ensure you don’t overcommit your finances.

So how do you work out what you can afford?

You will need to consider your assets and your own risk profile and whether or not the franchise system has bank accreditation.

Your assets

Start by listing your assets and your liabilities. You will need to have equity behind you for a financial institution to consider a loan.

It is important to consider the amount of risk you are prepared to take in this business venture. If you have accumulated assets while working, are you game to put them all at risk? Perhaps you would prefer to limit your risk to a portion of the assets?

Risking some but not all of your assets probably means a lower return – will that suit you?

There’s no wrong or right answer, this is an individual preference.

Tim Kilham at Lanyon Partners, says “It is worth noting that just because you have a certain borrowing capacity, say $500,000, it does not mean that you should spend $500,000. The amount that you will be prepared to spend will depend on your risk profile and a whole range of other factors.”

Bank accreditation

A proportion of franchises are bank accredited (these are usually well established systems) which means the bank has confidence in the brand as a business. For a franchise buyer that means the bank may lend up to 70 percent of the purchase costs of the franchise.

But if the franchise is not accredited, it is likely the bank will require you to have adequate assets as security for your loan. And this usually means property.

A bank may lend up to 80 percent of what it considers the value of your property – remember the bank's valuation of your real estate may be far more conservative than yours.

So how much can you afford?

Let’s look at an example. We will assume your property is worth $600,000 and has a mortgage of $150,000 attached.

The bank will be prepared to lend you 80 percent of the value of the house, a total of $480,000, but you already have an existing mortgage debt of $150,000. So the bank will lend you $330,000.

There might be room to get a larger loan from the bank dependent on the bank’s familiarity with the franchise system, your relationship with the bank and how keen the bank is to see the deal through.

If your franchise of choice is accredited, the amount you can afford is increased because the bank will lend against the franchise itself, and your assets.

Working capital

You will need to consider the costs of running the franchise business, and how much money you will need to sustain yourself and your family until the business starts making a profit.

Many a business has come unstuck through cashflow difficulties and it is common to underestimate the amount of working capital required. This needs to be calculated into the budget.

Of course you may be able to fund a franchise from a personal loan, or through family investments.Whether you are seeking external monies or self-funding, it is always worthwhile conducting a stringent analysis of your finances before committing any funds or signing up to a franchise.

Best practice in the franchise buying process would be to seek both legal and financial independent advice.