Franchising 101 July/August 2020 Resource Articles Ultimate Guide to Buying a Franchise

Franchise Financing Fundamentals

When you’re investigating the wide range of franchise opportunities available, it’s easy to get caught up in your search. With so many new 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 you can set realistic expectations for your franchising future.

Here are some of the important financial questions you need to address so you can make your franchise dreams become reality.

Can I afford this?

This is one of the most important questions you need 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 didn’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 – 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.

Where is 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 total cost of the investment. 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.

What are lenders looking for?

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.

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?

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.

To learn more about business plans, check out the Business Plans and Financial Management Basics article on page XX of The Franchise Guide.

What are some unexpected costs I might encounter?

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 so 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.

How can I improve my chances of securing financing?

Once you have a full understanding of your personal financials and financing requirements and have crafted a great business plan, there are a few things you can do to help secure that loan when you meet with your lender:

  • Establish a good relationship with the banker. Approach the same bank you use personally or find out whether your franchise system already has banking relationships in place and can give you an introduction.
  • Be prepared to answer any questions the lender might have during your meetings. Be open and honest. Know all the information contained in your business plan in detail and be ready to support your assumptions.
  • Present yourself well and dress professionally when meeting with your lender.
  • Plan ahead and approach your bank as early as possible. Even with an amazing business plan, if you leave financing to the last minute, the deal might not get completed. This can also indicate a lack of organization and preparedness on your part.
  • Offer a resume of your previous experience. Even if your background isn’t in franchising or the industry in which you’ll be operating your franchise, showing a history of success can help.