Financing Your Franchise

In the NatWest/British Franchise Association (bfa) annual survey* a supplementary set of questions was asked of attendees to the bfa seminar, Franchise Alliance seminar or an exhibition but had yet to purchase a franchise. It found that up to one year after attending 30% were still considering buying a franchise. A further 31% did not appreciate that they would have to pay for the business. Whilst the survey did not go on to ask whether they thought they could purchase the business over a period or that they are free, it highlighted the requirement for finance. Mark Scott reports.

Those that went on to purchase a franchise probably used a mix of their own funds and borrowed money. According to the NatWest/BFA Survey* two in five franchisees need to borrow to set up their business, with the vast majority doing so from a bank.

Banks will typically lend up to 70% of the set up costs for a proven franchise. For one that has a limited track record this will be nearer to 50%, in line with a normal start-up business.

Bank finance can take a number of forms. Firstly there is the business loan. This will be for the capital expenditure and could include the franchise fee, equipment, vehicles, shop fit and office supplies. Loans will normally run for the length of the legal agreement, as there is no certainty that either the franchisee or franchisor will renew on expiry. In most instances the bank will seek security when the finance is in excess of £15,000 to £20,000. This normally takes the form of a second charge on property, although it can also be a charge on stocks and shares, endowment policies or even cash.

If there is no security all is not lost, as provided the bank's only concern is a lack of security they can utilise the Small Firms Loan Guarantee Scheme, supported by the Department of Trade and Industry (DTI). Under the scheme, the DTI guarantees 75% of the loan. For example, if a franchisee wishes to borrow £100,000, the DTI will guarantee £75,000. The bank will then decide whether the remaining debt of £25,000 is an acceptable risk to take. In return for the guarantee the franchisee pays a 2% premium to the DTI.

Most loans from the bank will also have the ability to provide capital or capital and interest holidays at the outset. This will permit the franchisee to build their business before repayments to the loan commence. These holidays can be for up to 2 years, though clearly the repayments, when they commence, will be higher the longer the holiday. NatWest loans also allow for flexible payment options such as mid term reductions or increases to the monthly payment. They will also allow for full repayment with no penalties.

An alternative to the business loan may be to take out additional borrowing on your mortgage. Quite often the rate will be lower than a business loan. However repayments will commence immediately, rather than obtaining a holiday and interest will be payable over a longer period, dependent on the remaining term of the mortgage. This may mean you will pay more over the longer period, even though the repayments will be lower.

Financing of the equipment or vehicles may be undertaken using asset finance or put another way leasing. That way the bank's security will be the asset. Repayments to this type of finance will be over the life of the asset. After this period, depending on the type of asset finance taken, you may own the asset or it is returned to the finance provider and a new arrangement is entered in to.

The next type of finance a franchisee may require is an overdraft. Typically this is used to buy stock before it is sold, pay wages or provide goods and services in advance of receiving payment. The amount required will be determined by the cashflow you provide to the bank. Some franchisors will assist in compiling the cashflow but if not NatWest can provide a CD-ROM for this purpose.

An alternative to the overdraft is factoring or invoice discounting. This is used in business to business franchises, such as recruitment and printing companies. It shortens the period from issuing an invoice to receiving payment. If a factoring company is not used most invoices provide for 30 or 60 days credit. Therefore you would receive the money owed after this period has elapsed. If you use a factoring company once an invoice has been issued they will make an immediate payment to you of up to 80% of its value. The company pays the remaining 20%, less their charges and interest, on settlement. The full factoring service includes the company issuing and collecting your invoices on your behalf. With invoice discounting the franchisee undertakes this activity and copies the invoice to the factoring company who makes the payment up to 80% to the franchisee. The second method is a slightly cheaper alternative, as there is not as much administration undertaken by the factoring company.

Finally another way of raising short-term finance is through a business card. This allows you to purchase goods and services without making a payment for up to 38 days.

NatWest lends to franchisees through a network of specialist Franchise Managers, who are based in local business centres across the UK. They have a detailed understanding of franchising and mix this with the knowledge of the location in which they operate. We run regular workshops to ensure their knowledge is up to date.

When dealing with a potential franchisee the Franchise Manager will want to know not only which franchise you want to purchase but details about yourself. This is because your success will be determined by the amount of commitment and enthusiasm you have.

Before lending, a business plan will be required and should include details about the franchise, the costs, the sector it operates in, their competition, both locally, regionally and nationally, your CV, your assets and liabilities and projected financial information. The Bank's Business Software, including a template business plan can assist in drawing up your own plan. If you are buying an existing franchise business we would like to see the actual financial performance; the last three years would be helpful.

Many franchisors will assist in completing a business plan, however the Franchise Manager will expect you to know and understand the various statements and financial figures it contains. There will undoubtedly be questions about parts of your plan. The financial information, particularly the forecasts, will help you to assess the performance of the franchise in the early months.

A bank does not endorse or recommend any franchise, this decision should be sought by research into the franchise.

*Source United Kingdom Franchise Survey 2004 BFA/NatWest