How do I fund, or raise finance, for a franchise?
It is a big step from deciding to start a franchise to actually opening your doors for business. For many, one of the biggest hurdles is approaching the bank for finance.
Of course, there is a lot of work to do before you will be ready to part with any money, you will need to research your chosen franchise, making sure that it is the right one for you and that you are fully aware of what is involved.
You will need to ensure that you can afford to purchase the franchise you are interested in, and set up your new business.
The first step is to establish how much money you can invest in the business - what can you afford to invest? Have you got savings? Can your family help? Are there any other sources of finance for a franchise available to you?
Hopefully this section will give you some guidelines to work to in order to be able to approach a Bank for finance in a confident way, with an awareness of the type of questions likely to be asked.
Approaching banks for finance
Banks have learnt that it can be safer to lend to franchisees of well-structured ethical franchise systems. The track record of the franchisor is important to a bank when assessing whether to lend finance. Franchise opportunities with a good reputation and track record will be ranked higher when it comes to a bank offering finance. For an established franchise, the major banks can lend up to 70% of the start up costs, for new franchises the figure will probably be around 50%. With this in mind,
- How much finance will you be able to borrow? Prepare a full list of your personal expenditure mortgage, hire purchase, household bills, and so on. This will show how much money you will need to take out of the business in order to live.
- What security can you give to back up your loan? You might have a life policy with some value, or have equity in your home.
- Start preparing your business plan - this is a vital document to obtain finance from the bank. Your chosen franchisor will often help you with this.
A. WHERE TO START
As part of your business plan, you will need to prepare cash flow forecasts for the first couple of years of the business. Your franchisor will help, but you need to be sure that you understand the figures, what are they based on, how much do you need to turnover in order to break even?
Some banks use the following approach to assess your request for finance.
Who are banks lending money to?
The bank will carry out a full review of your background and reliability, your training, qualifications, and track record, financial resources, suitability to run the business.
A franchisor will also look at this to ensure that you are a suitable franchisee.
How much are you looking to borrow?
Banks will normally expect the franchisee to contribute at least 30% of the total cost of the franchise; this contribution should come from your own resources.
Apart from the actual amount the bank will also look at
- the purpose for which the money is going to be used and
- it's effect on your business
- is there sufficient demand for your product or service (the -fact that you are going to be investing in a tried and tested franchise format helps here)
- how will the money borrowed benefit the business?
- What type of finance are you looking for overdraft, loan or a package of financial services?
- how much are you investing in the business? Normally you are expected to contribute towards the total start up costs from your own resources
- have you asked for the right amount, is it too much or too little?
Your franchisor will normally help with setting out details of start up funds required and help with the preparation of cash flow forecasts.
B. REPAYMENT - how do you intend to pay back the money?
It is not in any one's interest to lend you money unless you can repay it.
- Where is repayment coming from
- Future trading profits after allowing for all your other financial commitments or from the sale of an asset?
- What assumptions have been made in the cash flow forecast?
- What levels of sales are needed to break-even and are they achievable?
- Is there a contingency plan for any setbacks?
C. SECURITY - how much risk is involved?
The bank must assess the risk of lending to you and decide whether security is required. This will depend on their evaluation of your business as a whole
- the prime source of repayment will be cash generated by your business and no amount of security will ever be acceptable if they feel that your business is not viable.
- The last thing they want to do is realise any security - they would much rather see a successful business continuing to trade.
They recommend that you take independent advice from your solicitor before you provide security.
If no security is available, they may be able to consider finance under the Government's Enterprise Finance Guarantee, if your business is eligible. This is a Government backed scheme to guarantee 75% of borrowing (for both businesses under and over 2 years established) where security is not available and where that lack of security is the only bar to a bank lending the money.
D. INTEREST & FEES - how is it calculated?
When the bank set an interest rate they take into account a number of factors including your stake in the business, security deposited and their evaluation of the risk involved. There are some special finance schemes for some of the larger, well-established franchisors. They may also charge a fee to cover the costs of setting up new borrowing and completing the security arrangements.
Forms of finance
There are several sources of finance for a franchise available in different formats. Loan accounts are most often used for the purchase of assets e.g. property where the loan will run for a longer period or a vehicle purchase where the term of the loan will be much shorter to reflect the rapid depreciation of the asset. Fixed interest rates are often available.
An alternative method of funding working capital is invoice finance, which involves raising finance using your debtor book. The advantage of this is that cash flow is directly linked to business expansion. This method is not suitable for all businesses and your bank will be able to advise you.
Another method of finance to consider is asset finance to fund the purchase of equipment for the business. This can help ease cash flow by spreading repayments over a period of time instead of making a one off investment.
As a potential franchisee, you are however in a better position than a self-employed person setting up a business from scratch. You have the backing of a proven business format and details of how similar franchisees operate to show the bank.
© Cathryn A Hayes - Former Head of Franchising at HSBC Bank - All rights Reserved
Total cost of opening a franchise
by Cathryn A Hayes - Former Head of Franchising at HSBC Bank
It is important that you do your planning and forecasting carefully and have fully researched the likely costs that will be applicable for your proposed franchise.
Start-up costs for opening a franchise can vary dramatically based upon the type of franchise involved and you will need to take account of costs from the lists below, which may be applicable.
- Initial franchise fee
- You may need to purchase or lease a liveried van
- Fund opening stock
- Leasing premises
- Refurbishment requirements
- Branding, fixtures and fittings
- Professional charges such as lawyer, architects and surveyor's fees
- Recruitment costs
- Marketing costs
- Working capital
- Training costs
- Ongoing management services fees
For an established franchise, most of the major banks will lend up to 70% of the start up costs, for new franchises the figure will be 50%. You will pay the borrowed money back over a period, usually 5 years, depending on circumstances.
Once you have established the figure for your own investment in the franchise, you can start preparing your business plan - this is a vital document to obtain finance from the bank. As part of your business plan, you will need to prepare cash flow forecasts for the first two years of the business. You need to be sure that you understand the figures, what they are based on and how much you will have to turnover in order to breakeven.
Cathryn Hayes, Former Head of Franchising at HSBC talks on franchise costs
How much does it cost to open a franchise?By Richard Holden - Head of Franchising, Lloyds Banking Group
The level of investment in franchise opportunities varies from a few thousand pounds up to several million pounds therefore you should select an opportunity that fits into your price range and that will not overstretch you financially. Many unsuitable opportunities are easy to eliminate on price, inability to deliver the income you require, business type and industry sector.
The Internet is invaluable when researching information on franchises. Trade magazines and exhibitions are also excellent resources available to you. Be aware that there is no standardisation across the franchise media regarding advertised investment levels, which can be confusing for potential investors. What you really want to know is the likely total investment costs including all equipment costs and working capital needed to operate the business. Unfortunately this information is not always immediately transparent. Ask the franchisor for a full breakdown of the investment and what you get.
You need to carefully research the financial aspects of the business and seek professional support where necessary. When looking to finance your franchise business it is best to approach a franchise specialist bank. The bank's franchise departments regularly evaluate franchises and monitor the ongoing performance of franchisees. The level of finance available from a franchise specialist bank will depend upon the strength of the franchise system as well as your business plan. It is always advisable to have a reserve of funds that you can draw upon in case the business takes longer than expected to get established.
Steps to financing a franchise
by Cathryn A Hayes - Former Head of Franchising at HSBC Bank
You've decided you may be suited to starting a franchise, but you have no idea how to finance it. Where do you start?
A good franchisor will encourage and help their franchisees with business planning, both at the outset and on an ongoing basis - helping the business to get off to a flying start and continue to develop.
Many small business owners are just too busy to look at what is happening in the market place, what competitors are up to, how customers' needs might be changing - but a good franchisor will be looking at research and development, helping their network of franchisees to keep ahead of the game.
All this support means that banks are going to be much happier to lend to a start up franchisee.
But before you are ready to talk to the bank about borrowing money to start your franchise, you need to establish how much funding you will need.
There are a number of costs which need to be taken into account, depending on the type of franchise - the initial franchise fee is really only part of the picture. For instance, an owner/operator franchise may need to purchase or lease a liveried van and they will need to fund opening stock.
A retail franchise will incur the cost of leasing premises and any refurbishment requirements as well as shop front, branding, fixtures and fittings. Franchisees would also need to think about professional charges related to the property transaction, such as lawyer, architects and surveyor's fees, as well as insurance. If employing staff, there may be recruitment costs; the franchisee may also need to provide uniforms. There will be marketing costs involved with an official launch of the business.
Working capital will also be required - what you need to live on prior to the business generating cash flow and profits. Find out whether training costs are included in the initial franchise fee; if not, these will have to be factored in.
Once up and running, you will pay the franchisor ongoing management services fees - this may be a percentage of your turnover, a mark up on products provided or a fixed monthly or weekly fee.
You should do your homework, and fully research what you will be getting for your money both at the outset and once your business is established.
For an established franchise, most of the major banks will lend up to 70% of the start up costs, for newer franchises the figure will probably be around 50%. You will pay the borrowed money back typically over the length of the initial franchise agreement.
The first step is to establish how much money you can invest in the business - what can you afford to invest? Have you got savings, can your family help?
Prepare a full list of your personal expenditure: mortgage, hire purchase, household bills, and so on. This will show how much money you will need to take out of the business in order to live. Consider what security you can give to back up your loan, you may be a life policy with some value, or have equity in your home.
Start preparing your business plan - this is a vital document for obtaining finance. Franchises will often help you with this. As part of your business plan, you will need to prepare cash flow forecasts for the first couple of years of the business. Your franchisor will help, but you need to be sure that you understand the figures, what they are based on and how much you will have to turnover in order to break even.
It is important to consider the financial implications carefully before buying a franchise. You are entering into a long term commitment and need to get the finance right at the outset. Don't do it on a shoestring, but don't borrow more than you can afford to repay.
Franchise loans available
There are a range of options available to you if you are looking to finance a franchise - see below for some of the most common methods used by new and existing franchisees looking to obtain franchise finance. UK banks and other lenders will be able to give you more information on these sources of finance:
- Easy to arrange
- Pay interest only on what you use - calculated on a daily basis
- Flexible borrowing to suit your circumstances
Small Business Loan
- Borrow between £1,000 and £25,000
- Repayments and interest rate fixed for the life of the loan
- Repayment terms between 12 months and 10 years
Flexible Business Loan
- Suitable for limited companies borrowing over £10,000 or sole trader and partnership businesses borrowing over £25,001
- Select a fixed or variable rate - the choice is yours
- Interest payable monthly or quarterly
- Repay over periods of 12 months to 15 years (10 years for fixed rates)
Enterprise Finance Guarantee
- A source of borrowing to help you expand or diversify your business or increase your working capital
- Government guarantee which secures loans, covering 75% of each qualifying loan. Invoice Factoring - Invoice Finance
- Improve your cashflow by releasing cash from your invoices
- Get up to 90% of the invoice value by the next working day
- Protect against late or bad payers.
- Buy, extend or develop business premises
- Tailor your commercial mortgage to your needs
- Designed specifically for commercial owner occupation
Business Credit Card
- Save time and money by separating personal and business spend
- Improve cash flow with up to 56 days interest free credit
- Special offers and discounts from leading retailers
- View your card transactions online using Business Internet Banking
- Buy your goods and services securely online.
Some franchisors may ask prospective franchisees to pay a deposit at a very early stage in the recruitment process - clearly it is vital that you know the terms under which the deposit is taken and what rights it will provide.
There should be a deposit agreement, setting out what territory is being secured and how long for, as well as how and when any deposit would be refunded. Under British Franchise Association rules, the deposit, less any direct expenses actually incurred by the franchisor, should be refundable if the prospective franchisee decides not to go ahead.
Kate Legg, at Higgs & Sons solicitors advises:
"Franchisors often request that a deposit is paid as a sign of the franchisee's commitment and to separate the "serious" applicants from the time wasters.
Deposits are particularly common:
- if the newcomer is buying a franchise business from an existing franchisee of the network, when typically the buyer will pay a 10% deposit on exchange of the sale and purchase agreement;
- if the new franchisee is setting up in a virgin territory and needs to find suitable premises, when the franchisor may ask for a deposit to be paid upfront while the franchisee looks for suitable premises. Once premises are found, the franchisee will sign the franchise agreement and pay the balance of the franchise fee.
From a franchisee's perspective, paying a deposit may secure their chosen territory and give them exclusivity whilst they carry out further steps in preparation for signing the franchise agreement.”
Before you part with any cash, you should ensure that you fully understand why you are being asked to pay a deposit and in what circumstances it will be refunded. The deposit paid should normally be credited against the franchise fee once you have decided to proceed.
HSBC's advice is that all legal contracts should be vetted by a solicitor specialising in franchising, including deposit agreements and any confidentiality agreement you may be asked to sign before detailed financial information is made available.
Initial franchise fees
The initial franchise fee varies from company to company and is paid by the franchisee when the franchise is granted. The initial franchise fee covers the cost of training, recruiting, territory analysis, site identification, specialist equipment, stationary, franchisee launch, etc. In addition, there will be an element of recovery of franchise development costs by the franchisor.
On-going franchise fees
The on-going franchise fee is usually based upon a percentage of the ‘gross revenue' or sales of the franchisee after deducting VAT. There is no set formula; rather it depends on the split of responsibilities between franchisee/franchisor. The more the franchisor does the higher the fee. In some cases there will be no on-going fee - it will be covered in a mark-up on the product. There are also cases where the franchisor will justify an increase in fees on issues such as extra start-up costs and inflation. In any case the type of fees to be paid, its regularity and whether it can be increased or decreased should correctly reflect the services the franchisor will provide, and should be properly communicated to the franchisee before the franchise agreement is signed.
You therefore need to know:
- How much the royalty fee is?
- How often it is to be paid?
- Is it a percentage or fixed amount?
- If a percentage, what is it based on?
- How does it compare to other franchise systems?
Advertising fees are used to advertise the franchise system. Normally an advertising fee is based upon a percentage of gross sales or net sales (though it can sometimes be a stated amount). They typically range from 1% to 5% of gross sales.
The fees are often put into a regional or national fund to be used for either regional or national marketing or advertising campaigns. Franchisors in their start-up phase may not ask for an advertising fee to be paid, as they would not expect to achieve any real benefit, i.e. in terms of increase in sales or brand awareness, via a regional or national campaign. They will however expect the franchisee to pay for local advertising to promote their franchise.
You need to know:
- What the fee is?
- Is the same fee paid throughout the network?
- How it compares with other systems?
- What you get for your money?
- If the franchisor can spend the fee on how they see fit?
- Will an advertising fee benefit the system?
- Or your franchise?
- The greater the perceived reputation of the franchise, the higher the initial fee.
- The greater the reliance on the franchisor's efforts and support, the higher the fee.
- Renewal fee is when a franchisee is charged a fee by the franchisor on granting an extended contract term.
- Transfer fee can be charged when the franchisee sells the outlet to another person.
- Where on-going fees are absent they are normally substituted by mark-ups or rebates on products supplied to franchisees normally substitute them.
- On-going fees are structured as a percentage of turnover, but in some cases a flat weekly or monthly payment is charged.
- Advertising or marketing fees are often collected for the promotional activities on behalf of the whole network.
- ‘Special' fees may also be charged by the franchisor for services such as training in the use of new software.
Franchise Business Plan
Your business plan should outline what you want to do, how much money you need to do it with and how you plan to pay the money back. It should also include a Profit Forecast and Cash Flow Model.
However, there is more to the Business Plan than getting funding. It will help you clarify your ideas and objectives. You will have to answer questions on your business objectives, your product or service, pricing methods, your customers and competition. (Many Franchisors will assist in the preparation of a business plan) But remember that it is your business and your business plan. Your Bank will be interested in your long-term forecasts - but your family will be equally interested in your short-term projections. Will you be able to afford a holiday next year? What will your standard of living be?
Preparing, presenting and defending your business plan is a real test of your business acumen. Producing the plan tends to bring everything out into the open, focuses your mind on all elements of the business, and helps put your thoughts down in black and white.
Preparing your business plan
Your Business Plan is the 'sales document' for you and your business. It's preparation and presentation should project the image you want for your business. Its content should be clear, concise, to the point and divided into logical sections.
As a guideline, your plan should structure broadly as follows:
- Describe the purpose of your Business, briefly outline the concept.
- Include YOUR overall business objectives.
- Decide on the 'legal status' of your business - sole trader, partnership, limited company or co-operative? All have benefits and shortcomings. Find out which is right for your situation.
2. The Product or Service
- Describe precisely the product or service that your business will offer. Include any relevant history of the product or service and try to avoid any jargon.
- List the distinctive qualities of your product or service and describe your 'Unique Selling Point' (USP) - the key feature which makes your product or service stand out in the market place.
- Describe how your product or service can be developed in line with a changing market.
Any business is only as good as its people.' You should include details of anyone who will be involved in making your business a success. These people are a very important asset and this is therefore a key section of your Business Plan. Include in this section:
- A précis of each person, including their personal assessment of their attributes, strengths and weaknesses as well as your own assessment of each person.
- Their relevant experience, commitment and reasons for involvement in your new venture.
You should also include a detailed CV for each person in the 'Appendix' at the end of your plan.
'YOUR BUSINESS PLAN IS THE SALES DOCUMENT FOR YOU AND YOUR BUSINESS'
4. The Market
This is probably the most important section of the whole Plan - without a clearly defined market your business will not succeed. If you can show that you have 'done your homework' in this section, you will gain credibility for the whole Business plan. Your franchisor will also have research in this area.
- Describe the current conditions in the market place for your product or service.
- Detail any relevant facts and figures relating to the market sector(s) that you will be targeting - for example geographical location, size (in terms of people and money), expected growth, and the type(s) of potential customers for your product or service.
- Give details of your competitors and explain why your potential customers will choose your product or service rather than the competition.
This is the point where research pays off. You should make use of the wealth of business information that is available about markets, competitors and customers.
5. The Marketing Plan
A business without a Marketing Plan is like a ship without a rudder. Your company must therefore have a clearly defined marketing plan, which will include
- Your marketing objectives - for example number of sales or market share.
- Where your product or service will be 'positioned' in the market place in terms of price, quality, image etc.
- What your planned marketing communications are - advertising, leaflets and brochures, etc.
- How your product or service will be distributed and /or sold eg. Through agents, sales teams, etc.
- What customer care policy is planned and how it will work.
Any interest that you have already generated or details of possible orders you have already taken should be include in the appendix.
WITHOUT A CLEARLY DEFINED MARKET YOUR BUSINESS WILL NOT SUCCEED.
6. The Operation
Having an efficient operation can be the key to a profitable business. This section should describe how you will supply your product or service. Your Franchisor will have set systems that you will have to adhere to.
- Include your sources of supply, labour and materials.
- Detail the resources required to operate your business, differentiating between what you already have and what you need to acquire.
- Identify any critical procedures or sensitive issues and outline possible alternatives.
- State where you intend to operate from - your current premises and future requirements.
- Outline your current Health and Safety policies - if you don't comply with your statutory obligations, you will need to take action.
7. The Premises
You need to decide on the most appropriate premises for your business needs together with the franchisor.
Whether you are working from home or looking for factory premises, you need to consider the following:
- Future business growth
- Running costs and Uniform Business Rates
- Planning Consent
8. Financial Information
Start with a summary of the key facts:
- The forecast profit (or loss) for the year.
- Whether financing is required and if so, how much and where the money is to come from.
- The 'break even' sales for the business should be calculated and shown as a percentage of your anticipated sales.
- Details of the money you need to take out of the business to live on - your required income'.
A detailed schedule of your required income should be included in the Appendix.
b) Profit & Loss Forecast
Your forecast profit (or loss) should be based on your anticipated sales, minus your direct costs and overheads. The assumptions made in producing your forecast should be listed:
- Include as much detail as possible to justify anticipated sales.
- Any direct costs (materials etc.) should be detailed
- Don't forget your overheads - it is just as important to show how they have been calculated.
c) Cash Flow Forecast
Cash will flow in and out of your business - often at different rates and times for example, you may have to pay for materials in advance, yet wait months for payment after you have sold your product or service.
Situations like this can lead to cash flow problems in an apparently profitable business. To anticipate how much cash your business will require, you should convert your profit and loss forecast into a cash flow forecast. List your assumptions:
- When will you get the money from sales.
- When will you have to pay suppliers.
- The timing of specific overheads.
- How much capital equipment that you require for your business. Differentiate between existing equipment and expenditure still to be made - how much and when.
Properly done, this will tell you when your business is likely to be short of cash and it will enable you to plan for this.
This is the final section of your Business Plan. It should include the detailed information mentioned earlier - CV's, details of orders etc.
You can also include:
- Details of premises
- Insurance details
- Product brochures, photographs and letterhead
- Anything else that you believe will enhance the credibility of you or enhance the credibility of you or your business.
More on business plans from Cathryn Hayes, Former Head of Franchising at HSBC, watch this short video:
Getting the business plan right!
by Cathryn A Hayes - Former Head of Franchising at HSBC Bank
The length of time taken to obtain a loan varies according to the complexity of the deal and the type of franchise being purchased. For example, if a property lease is required or the bank requires security, such as a charge on a property, this can take longer than for a franchisee starting a low cost business from home.
Typically the bank can provide an agreement in principle within 48 hours of meeting you, providing we have all of the information required. You can help speed up the process by ensuring you have fully completed your business plan before approaching the bank.
The business plan will clarify the main business idea of the chosen franchise and define the long-term objectives. It provides a blueprint for running the business and a series of benchmarks for you and your franchisor to check progress against.
A good business plan will contain the following:
Summary business description - details of the franchise being purchased and the financial needs.
Market analysis & product / service - research and identify local competition and assess what the likely demand of the product / service will be in the specific territory.
Market Strategy - outline intentions for marketing the product / service and how the sales figures shown in the projections will be generated.
Management plan - include details of the type of business (e.g., sole trader, limited company) and CVs of key personnel. Set out the structure and key skills of the management team and staff.
Financial data - at least two years projected figures are required, including a balance sheet, cash flow and profit & loss statement, ensuring that projections correspond with the information outlined above and they're realistic. If it is a resale franchise, include details of the existing business being sold. Has the business been growing? Is it profitable? A copy of previous years' accounts should also be included.
SWOT analysis - a one-page analysis of strengths, weaknesses, opportunities and threats.
To summarise, here are our fundamental rules for writing a plan:
- clarify the purpose of your plan before you write it
- focus on the key information the reader will want
- highlight future plans as well as describing the current situation
- be realistic
- waffle or include unnecessary detail
- base your plan on over-optimistic assumptions
- ignore competitive threats and weaknesses
Evaluating financial aspects of a franchise
By Michael Johnson, Managing Director at Card Connection
Buying a franchise is an investment in the future. However, if you have never run your own business before, accurately evaluating the long-term prospects of a potential franchise can prove challenging. In order to do this, it is necessary to make a detailed examination of the financial aspects of the franchise to determine how much it will actually cost to buy initially, to identify the likely return on investment, over what likely time frame, and assess the long term outlook and potential growth.
However, many people fall in love with the idea of running their own business, becoming enthused about the product or service, then tend to ‘bury they heads in the sand' when it comes to looking at the cold, hard facts surrounding money. Cash-flow, capital expenditure, expenses and invoices may not be as exciting as the concepts of flexibility and freedom encompassed in the prospect of self-employment however; they are an essential and integral part of running any successful franchise.
So, if you are like most people and shy away from figures, keep it simple. At the most basic level you need to understand you can earn enough to live on. Work out what this figure is. Ask you potential franchisor for the actual net profit of other similar sized franchise territories and see if other franchisees are earning what you need make to fund your lifestyle.
You will also need to remember initially, expenses will be incurred buying the franchise, training and purchasing any necessary vehicle or equipment. Also, although many franchises allow you to earn money from day one, there is an inevitable learning curve so consider how long it will take to reach your net income goal. Will you need additional funding while your business gets up and running?
The franchise may work well as a business currently, but you also need to think long term. What threats are there from competition, potential new regulations or rising fuel prices that might erode your profit margins? Will you be able to sustain that net income figure in years to come?
In fact, for any business to ‘stand still' financially it actually always needs to be growing and taking on new customers to make up for changes in the market which may see old customers go elsewhere or a change their business model so they no-longer require your services. For this reason, it is essential to consider the degree of untapped potential in any franchise.
The ideal franchise would be one where there are potential customers that have not yet been introduced to the product or service. Similarly, a business where there is the chance to further ‘upsell' existing clients is also a good sign. Perhaps the franchise may not have been run as proactively as it could have been or the area was larger than the outgoing franchisee really wanted to manage. Be careful though if you are looking at a ‘virgin' territory. There will be untapped potential but it will always be more difficult to establish the business from scratch than buying from an existing franchisee. There may be a reason why the franchise has not expanded into the area before, such as an aggressive competitor or it may be a low income region.
It is difficult to determine how the future will look, however an educated guess will indicate that costs will continue to rise, competition will become tougher and profit margins will always be more difficult to maintain. Therefore, with any franchise or business opportunity, it is essential there is room for the operation to expand and grow, to take advantage of economies of scale and improve efficiencies, in order to protect your future and to see a return on your investment long term.
About the author
Michael Johnson is the Managing Director of Card Connection. Card Connection is part of UK Greetings, the largest publicly owned greeting card publisher in the world and has limited vacancies for franchisees that are keen to run an expanding business. Successful candidates would ideally have some management experience as, once established, they would be expected to employ a small team, operate a warehouse and have several liveried vans on the road.
Verifying a franchisor's projections
by Cathryn A Hayes - Former Head of Franchising at HSBC Bank
One of the simplest and most effective ways to verify the projections given by the franchisor is to speak to other franchisees. All franchisors should be willing to provide you with a list of their franchisees, so that you can contact them to find out what their experience has been and if the financial projections produced by the franchisor were accurate and if not, what the difference was.
You should not be afraid to ask the franchisor to clarify how they have arrived at the figures in any draft business plan or prospectus, as part of your research. In addition, you should obtain a copy of the franchisor's filed accounts and possibly also the filed accounts of some of its franchisees. These are documents of public record, which can be readily obtained and will give an accurate picture of financial status of those businesses.
If you are not confident in looking at these figures, your accountant should be able to give you guidance.
Any projections provided by the franchisor will only be a basis for you to build your own business plan and projections - but they will at least give you a starting point. You should use them to check how you feel about the franchise and whether you want to go ahead. How long will it take you to get payback on your initial outlay, how much will you need to borrow to get the business up and running?
Money is not always the only factor when choosing a franchise, quality of life and the satisfaction of being your own boss with support from the franchisor and franchise network are also very important. However, you don't want to lose your hard-earned savings, so time taken at the outset to understand the costs and potential returns will be time well spent!
by Euan Fraser, AMO Consulting
There are lies, damned lies and projections - don't get confused by a franchisor's claims. It's easy really; you just need to think objectively.
You must take responsibility for understanding the financial projections that a franchisor gives you. As soon as you sit in front of your bank manager they're going to ask you what the sales figures are based on - it doesn't help if you sit there and say “err, emm, I just used the figures that the franchisor gave me”.
You'll need to have a good hard look at the source of the information that the franchisor has used. Here are few examples of what you need to think about:
Company owned units - these are run by experienced employees who know the product, service and systems. They probably won't be as enthusiastic as you are or have the same determination to provide high levels of customer service, but they know what they're doing. Can you really expect to start the business from scratch and grow it as fast as they can?
A pilot franchise operation - this is a good start but who was the pilot franchisee? Was it the top salesman in the company for the last 10 years? Are there any differences in the territory the pilot operated in? (eg Central London or one really big customer) Did the pilot inherit any business from the franchisor?
Top 10 franchisees performance - this isn't always helpful. The top ten franchisees may be based in city centres so that won't be too useful if you're in a small town; and let's face it you may not be as good as them when you start up.
Average of all franchisees - this is better. At least this gives you a starting point that could be based on someone like you. You may be better or worse than the average franchisee but these figures are definitely achievable.
So here's the watchword; be sure that you know the basis for the projections. Be sure they apply sensibly to your territory and that you check them against the actual experience of existing franchisees. Do not base the investment on what you hope will happen, base it on a realistic assessment of what has and could happen. So leave the rose-tinted crystal ball on the mantelpiece.
Of course at AMO Consulting we're happy to help; we have over 20 years of business planning experience. We provide a fixed fee review of your financial projections. For this we'll look at the figures you're given and provide a report that gives you an idea of the questions you should be asking and will challenge the assumptions you're using - and that's not a lie!
Banks like franchising!
by Andrew Fraser, Harper Macleod
“BANKS LIKE FRANCHISING” declares the current internet advert for HSBC. However, as the UK limps out of recession, is this really the case? Are banks lending to prospective franchisees? We spoke to two of the UK's leading franchise finance lenders.
“Yes” says Richard Holden, Head of Franchising at Lloyds Banking, “Particularly to well established and proven franchises”.
Cathryn Hayes, Head of Franchising at HSBC explains that “In broad terms, franchising is a safer option than going into business on your own. A franchisee should have a tried-and-tested format to follow, training and support from their franchisor, and a network of fellow franchisees to speak to - so although franchisees own and operate their own business, they are not doing it alone”. This support, Cathryn says “means that banks are going to be much happier to lend to a start-up franchisee”.
To obtain funding for a franchise, the banks need you to prepare a business plan. The business plan is important for several reasons:
1. It helps raise finance;
2. It demonstrates to the bank that you understand the business opportunity;
3. It is a useful working document for you going forward; and
4. It acts as a benchmark allowing you to measure the future performance of your business.
The bank manager will always want to meet you to discuss your business plan. At this meeting, Richard says, the manager will be looking to address the items in their aide-memoire: CCCPARTS or CAMPARI.
Some of the questions which the bank manager will need answers to before offering to finance a franchise include the following:
Are you trustworthy? Do you have a proven track record of repaying debt?
Are you up to the task of running the business?
What terms can the bank offer? If you present a risky proposition, the terms may be more favourable to the bank.
Why do you need the money?
How much do you need? How much are you putting forward yourself? (Why should the bank give you money if you are not willing to stake your own?)
How will you repay the bank? Do the projections stack up?
What security is being offered? Are there any gaps in your insurance cover that could lead to them being unable to repay the bank?
If you are looking to the bank as a source of funding you should pay close attention to this banking mantra and make sure that your business plan is up to scratch.
Another comment which Richard makes is that “Banks' franchise departments need to evaluate the franchise opportunity before they consider providing financial assistance to prospective franchisees”.
This means that banks will look into how the franchisor has established the network and may check whether the correct support structures have been put in place by the franchisor before considering lending finance. Franchise opportunities that use consultants who employ an “off-the-shelf” approach to establishing their networks are frowned upon. Instead Richard dvises franchisors to use consultants and advisers that have been accredited by the British Franchise Association, as “[such] advisers who are affiliated to the association must pass an accreditation process and demonstrate a track record of success in franchising before they can join”. So, from your point of view, you should not be afraid to ask your franchisor what advice they received in establishing their network and from whom this advice was obtained.
More on banks and franchising from Cathryn Hayes, Former Head of Franchising at HSBC
Why borrow from a bank with a franchise division
Potential franchisees often want to stay with their personal bankers when looking for finance but when looking for finance to purchase a franchise, its best to speak to those banks with a specialist franchise unit. Of the high street banks HSBC, Lloyds TSB and RBS/NatWest are all franchise finance lenders.
The main benefit of approaching one of these is that they understand franchising and the benefits of this business model compared to a conventional start up. This added to the lower risk of franchising, means that funding is more likely to be available.
One of the key roles of a franchise finance unit is to understand the business model and the wide range of franchises available. They can then share this knowledge with lending managers who will assess a potential franchisee's application for finance, so you can be confident that when you sit down with the manager, they will be able to have a meaningful conversation with you about the business and your aspirations.
In addition, the franchise team can provide valuable guidance and will be able to point you in the right direction to obtain the professional advice and support you need in making your decision.
Why banks reject applications for finance
by Cathryn A Hayes - Former Head of Franchising at HSBC Bank
If you have had a application for finance rejected, the first thing to do is to ask your bank why. This will help you to decide how you can improve things and possibly re-apply.
Below are some of the reasons a lending proposal can be rejected:
Insufficient income to pay back the loan
The bank will look at the cash flow forecasts within your business plan and check that the business is likely to generate enough cash to cover its costs, including the loan repayments. It may be that you need to take a closer look at your business plan, making sure that all the necessary information is included and check that the figures make sense.
Other sources of income
Lenders always worry about the ability of a new franchise to provide enough income for the owner to live on and service any borrowings they have, particularly in the early years. Luckily, many franchisees have a supportive partner behind them who often continues to earn a regular wage. This additional household income reduces the franchisee's dependence on the profits of the business. It is therefore important that a franchisee provides a summary of all their domestic income and expenditure, demonstrating just how much money needs to be taken out of the business in order for them to survive.
Poor credit history
When assessing a request for credit facilities from a business, information is obtained from the credit reference agencies on both the business itself and the individual owners of the business.
If the bank is unable to lend to you as a result of information from a credit reference agency, we are not able to share the information directly with you as the information is not ours. However, you can obtain a copy of your credit record for a fee by contacting the agency concerned. If your credit record contains items that are incorrect, you can apply to have them removed.
Lack of information
Sometimes a business plan is incomplete or lacking in important details - if the bank cannot see how the business is going to operate, or the plan doesn't contain a complete business plan and forecasts, it will be impossible to agree the lending. If you know of any issues that could cause the bank concern, discuss them at an early stage and provide supporting information to help put your case across.
Lenders need to understand your ability to provide enough income to live on and service any borrowings they have, particularly in the early years. It is therefore important that you provide a summary of all your domestic income and expenditure, demonstrating just how much money needs to be taken out of the business in order for you to survive.
Understand the figures
We see many examples of franchisees simply presenting figures given to them by their franchisor, without really understanding what they mean. As franchisors it is essential that you encourage your prospective franchisees to take ownership of their figures, particularly the cash flow forecast. If they are unable to explain these to the lender in a convincing fashion, it's likely they will be turned down for the finance they need to get their business off the ground.
It's not just a cash flow forecast
In contrast to the above, we are sometimes presented with a cash flow forecast and little else. The bank won't just focus solely on figures. The business plan needs to demonstrate that the franchisee has fully researched the local competition and that they understand their market etc. Whilst the cash flow forecast tells a lender what will happen, the business plan explains how it will be achieved.
It's not just about the franchisee
With over 800 franchises active in the UK it can be a mistake to assume that the lending manager knows all about every single franchise, although the specialist franchise units minimise this risk. It is therefore helpful that when the franchisee presents their business plan they explain exactly what help they will be receiving and the track record of the franchised business.
Whilst the majority of business plans we receive are perfectly adequate, we hope these few pointers will help make it easier for you to obtain the finance you need./
More on approaching banks for franchise finance from HSBC.
Does 'low-cost' mean 'low-risk'?
By Cathryn A Hayes - Former Head of Franchising at HSBC Bank
I often see promotional activity around lower cost franchises in magazines and on websites - these can be an excellent way to get into business if you don't have a great deal of capital available.
Due to their lower costs, they are often funded from savings or personal finance, which means that there may be no need to prepare a business plan as you aren't requesting bank finance. However, just because you may not be preparing a business plan, doesn't mean that you shouldn't do your research.
Here are some of the questions to consider:
- Think about the practicalities - if you are being told you can make say £3000 per month - start by looking at average sales, how many is that a week, a day, an hour? What would that involve, who are you selling to? Does that sound physically possible?!
- Learn about basic business terms - don't get fooled by top line ‘you can make £x' figures - this could mean sales rather than profit.
- Look closely at the ongoing costs - for instance, will you have to commit to buying a certain level of stock every month or pay a fixed monthly or weekly fee regardless of how well your sales are going?
- Is it a brand new product or service - if so, has it been tested and what were the (documented) results? Is it likely to be a fad/fashion purchase, if so, what happens after the first wave of excitement is over?
- Speak to existing business owners/franchisees who are already operating within the network - not just one or two people put forward by the franchisor, obtain a full list if you can and speak to as many as possible.
- Look on businesses for sale websites or places like Dalton's Weekly - are there large numbers for sale? This could mean that some of the franchisees are struggling to make the business a success
- Beware the charismatic, super-enthusiastic sales person - a really good franchisor will tell you about the down sides as well as giving you the glossy sales pitch. If all the discussions are about the need to make a rush decision, pushing you to avoid spending time researching - then take great care. Strong, ethical franchisors want well researched franchisees to make informed decisions, not ‘impulse buyers'.
Remember - one person's ‘low cost franchise' is another's life savings or rainy day nest egg. Make sure you don't rush into buying a business which could change your life with less research and planning than you would do when you are booking a holiday or changing your car!
Assessing finance requests
by Cathryn A Hayes - Former Head of Franchising at HSBC Bank
The following outlines a bank's basic approach to assessing a request for franchising finance and should provide a useful insight into the information needed before a financial provider will agree to lend the amount requested.
Person - your bank will look at your background and reliability; your training and qualifications to help establish your track record, financial resources and suitability to run a business. A franchisor will also look at this to ensure that you are suitable franchisee.
Amount - How much you'd like to borrow, how it's going to be used and how it will benefit the business. We will also consider whether there is sufficient demand for your product or service (the fact that you will be investing in a tried and tested franchise format helps here). How much you are prepared to invest in the business? Normally you are expected to contribute towards the total start-up costs from your own resources, but it is important to get the balance right. Often new start-up businesses underestimate how much they will need to borrow to make the business successful, therefore it is important to be realistic when presenting your business plan to the bank.
Repayment - It is not in your bank's interest - or yours - to lend money unless it looks likely that you can repay it. Therefore your bank will need to understand from the cash flow forecast how you can afford to repay the loan. What assumptions have been made? What level of sales are needed to break-even and is it achievable? Is there a contingency plan for any setbacks?
Security - banks must assess the risk and decide whether security is required. This will depend on an evaluation of your business as a whole - the prime source of repayment will be cash generated by your business and no amount of secur