July/August 2022 Resource Articles Ultimate Guide to Buying a Franchise

Franchise Financing 101

When investigating franchise opportunities, it’s easy to get caught up in the search. With so many unique concepts
and exciting brands to explore, the possibilities can seem endless. But before you delve too far into your research, remember that you need to consider the cost involved. It’s important to know your financial capabilities and limitations before you get started, so that you can set realistic expectations for your franchising future. Here are some of the important financial steps you need to take to make your franchise dreams become reality.

Ask yourself: can I afford this?

Assessing your means is an important first step when considering investing in a franchise opportunity. In fact, “Can I afford this?” is one of the most important questions to ask before you get started.

It’s crucial that you can not only afford the total cost of the franchise, but also that you have a cash buffer. The franchisor can provide you with a summary of the typical costs required to open the franchise—take a good look at these costs and make sure that once you pay the franchise fee, purchase or lease equipment, order initial inventory, and take care of any other start-up costs, you still have money left over.

You need to ask yourself whether you have the funds to buy a franchise and support yourself and your family during the critical start-up period. A common reason why new franchisees might fail is because they don’t have enough money going into the franchise. If you put every cent you have into acquiring the franchise, you won’t have the additional funds needed to support yourself during this time. A good cushion would include about three to six months of personal expenses, enough to cover living costs like rent or other home payments, food, and other bills.

You should have a complete picture of your financial situation at the ready, including a personal net worth statement, personal tax assessments for the most recent two years, and your credit rating, to find a franchise with the right financial fit.

Finding the money

Once you’ve gathered this information, you need to delve into the details of your assets. Many franchisors and banks have requirements for the ‘unencumbered equity’ a franchisee needs to have. Unencumbered equity is any cash you have that isn’t tied up in any way and doesn’t need to be repaid to anyone else.

Most franchisees will finance their franchises with a combination of equity (either personal equity invested by the franchisee or outside equity obtained by selling partial ownership to investors) and debt (loans). The amount of personal funds you’ll be required to contribute is usually based on a percentage of the investment’s total cost. Typically, between 30 and 50 per cent of the investment should be your unencumbered equity. Remember, taking on too much debt can be detrimental, because you need to be able to focus on growing your business and not on making debt payments.

Once you sort out how much equity you’ll be supplying and how much debt you’re prepared to take on, you’ll need to approach a bank to help with the financing.

A solid business plan is a major asset in securing financing. It helps you determine what financing you need, and how you’ll pay it back. A well-thought-out business plan should cover all the questions your banker might have about your franchise business and how it will operate.

Building a business plan

A business plan consists of a business model and a financial plan. The business model will outline the qualities of your business—the customers, the industry, the competition, and your qualifications. It should also identify any weaknesses and explain how you plan to overcome them. The financial plan should include a projected balance sheet, income statement, and cash flow statement. It should also answer any “what if…?” questions: what if sales drop by 25 per cent? What if they increase by 50 per cent?

It might be tempting to outsource your business plan to someone else, but remember, ultimately this responsibility lies with you—you need to understand and present your plans for the business, not someone else’s. While there are many business plan templates available, you should put your plan together and then consult with others, such as an accountant and existing franchisees in the system, to ensure the financial aspects are realistic and accurate.

Here’s a brief description of what should be included in your business plan.

Executive summary: The summary should describe the franchise you intend to purchase, including the background and track record of the franchisor.

Management team profile: The most important part of a business plan for many lenders, the profile should describe your skills and experience, and why you’re suited to own and operate the franchise—as well as the same information for any other members of your management team.

Description of products and services: Here you should provide specific details about the products or services you will be providing, how you’ll deliver them, and what sets you apart from your competitors.

Core market information: This section should describe your core market sector, current competitors and future prospects, your strengths and weaknesses, your existing customer base, and an estimate of the market share you plan to achieve.

Description of operations: This section should explain how you’ll produce/deliver your products or services and describe your location and the premises where you’ll operate.

Other supporting documents: You’ll want to include your resume (and those of your management team), job descriptions, credit reports, letters of reference, letters of intent, and leases or contracts and other legal documents that pertain to the franchise you’re purchasing.

Financial information: The financial section should address the business’ potential viability and include monthly budget and cash flow projections. It should also describe your financial situation and include a personal net worth statement. An accountant or financial advisor can be particularly helpful in preparing this section of your business plan.

Prepare for unexpected costs

Though you’ll try to account for all expenses in your franchise investment process, inevitably there are things that may come up depending on your exact circumstances. While it’s important to focus on the hard costs, including the location and equipment, you can’t forget about the soft costs involved. These include financing costs (interest on loans); working capital to use until the business breaks even; security deposits (paid to utility companies, for example); professional fees to retain lawyers, accountants, and others; and any required licences, permits, insurance, and training costs.

You should plan ahead to make sure you’re not strapped for cash a few months into your venture. These costs should be included in your business plan, so you can ensure that you find the funds to cover them.