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?
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 most important.
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 probably be around 50%. With this in mind,
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
PERSON - Who are they lending the 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.
AMOUNT - 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
Your franchisor will normally help with setting out details of start up funds required and help with the preparation of cash flow forecasts.
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.
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
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.
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
The provision of finance can be in several different forms. 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.
Â© Cathryn A Hayes HSBC Bank - All rights Reserved
Cathryn Hayes, Head of Franchising for HSBC since 1994, has a high profile within the franchise industry, acting as a judge on the prestigious British Franchise Association (BFA) awards which the bank sponsor.
Richard Holden has 23 years banking experience and has supported a wide range of businesses in the small business sector for years.