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.
The real cost of investing in a franchise
Article by Richard Holden, Head of Franchising, Lloyds Banking GroupThere is no standardisation across the franchise media regarding advertised investment levels, which can be confusing. You need to know the likely total investment costs including all equipment and working capital needed. Ask the franchisor for a full breakdown of the investment costs.
It is important that you fully research the likely costs before making any commitment to invest. Your business plan and financial forecasting should reflect the sales and operating costs you are likely to see, based upon the trading performance of existing franchisees in similar territories and your own local market research.
Costs for setting up a franchise opportunity can vary widely based upon the type of franchise opportunity you are interested in. You will need to consider the following when researching the true costs of investing in your chosen franchise.
- Initial franchise package fee
- Premises costs
- Refurbishment costs
- Fixtures and fittings
- Opening stock
- Licences (software)
- Telecommunications (landline, mobile phone, broadband etc.)
- Vehicle costs (consider leasing as an alternative to purchasing the vehicle outright)
- Vehicle livery and fit out costs
- Marketing campaign (Include launch program, PR, social media and networking)
- Marketing and promotional materials
- Business stationery
- Professional fees (solicitor, accountant, architect and surveyor fees)
- Memberships (trade associations, chamber of commerce, consumer groups etc.)
- Staffing costs
- Ongoing management services fees
- Ongoing national and local marketing and advertising costs
- Working capital
For well-established franchise brands, banks that specialise in franchising will consider lending up to 70% of the total start-up costs including working capital. For newer, less established franchise brands the available finance from a lender maybe lower. The term of the lending will be linked to the franchise licence, so if the initial licence term is 5 years then the maximum term for a bank loan will not exceed 5 years.
Once you have established the overall level of investment required, you can start preparing your business plan. The business plan is an essential document to obtain finance from the bank, but also it should be used as a working document to identify development areas as well as business opportunities. Additionally you will need to produce detailed cash flow and profit & loss forecasts for at least the first three years of trading.
You will need to have a good understanding of all aspects of the business, including the financials, to be able to present your case to a lender. The bank manager will ask challenging questions and expect you to be able to answer them confidently, so be prepared.
Financing your franchise plans
Article by Richard Holden, Head of Franchising, Lloyds Banking Group
For most people, knowing how much finance is available will be a key consideration as to the franchise opportunity that is ultimately chosen. So where is the best place to find out about your funding options?
Banks with a specialist franchise team, such as Lloyds, are a great starting point. For expert support and guidance contact the bank’s Franchise Department directly, not your local manager. The bank’s franchise experts will be able to give you an indication of the possible finance available and funding options for the franchise brands you are interested in, even before you’ve made your final decision.
Your chosen bank will ask to see your business plan, including the financial projections, to fully consider the financial assistance you require. Most franchisors encourage and support their franchisees with producing their business plan. Most banks provide business planning templates to assist business owners in writing their plan.
In addition to the help the franchisor will provide, it is important that you research your local market. Some business owners neglect this step and as a result have little real understanding of the local demand, competition and the changing needs of their potential customers before they start up.
Before you speak to the bank about borrowing money to start your franchise, you will need to establish how much finance you will require. To get an accurate picture ask the franchisor for a full breakdown of the costs including the likely working capital you will need. Don’t overlook any VAT that will be payable when setting up the business.
For well-established franchise brands, most of the major banks will consider lending up to 70% of the total investment including working capital however for newer, less established franchise opportunities the amount that the bank will lend is likely to be lower. The finance term will typically match the length of the initial franchise agreement, so if the franchise licence is 5 years the maximum term of a bank loan will not exceed 5 years.
As the bank is unlikely to finance the entire investment you will need to put your savings into the pot to fund your chosen franchise. The bank will ask to see evidence of your own investment to establish that the money have been saved over time and not raised through a personal loan or remortgage.
The bank manager will also want to see a breakdown of your household income and expenditure to identify how much money you need to live on and to establish whether the new business is likely to be able to generate sufficient profits for you to cover your personal commitments.
If you are looking to borrow in excess of £25,000 it is likely that the bank will require you to put up personal assets as security for any loan agreed. If you have a strong business plan but don’t have any personal assets to support the lending then the bank may be able to consider financing your plans using the Government backed Enterprise Finance Guarantee Scheme. Speak to the bank’s Franchise Department for guidance as to whether you would be eligible for this scheme.
It is essential to thoroughly research the opportunity and fully consider the financial implications before buying a franchise. You are entering into a long term commitment and need to get the funding right at the outset. Don't try to press ahead with insufficient capital, putting unnecessary pressure on the business from the outset, but don't borrow more than you can comfortably 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.
Preparing your 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.
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:
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
Article by Richard Holden, Head of Franchising, Lloyds Banking Group
When researching the viability of your chosen franchise opportunity how do you know that the financial projections indicated by the franchisor are indeed realistic and achievable?
One of the most effective ways of verifying the validity of the projections given to you by the franchisor is to speak to several existing franchisees. All ethical franchisors will provide you with a complete list of their franchisee network, so that you can contact them to find out what they have experienced and whether the financial projections indicated offer an accurate forecast as to the likely trading performance of the franchise.
Ask the franchisor to make it clear to you how they have calculated the projections in any franchise prospectus or draft business plan. They should tell you whether the figures have been based upon the average performance of their entire franchisee network and how recently they have been updated. Figures produced in a better economic climate may bear no resemblance to what a business can achieve in more challenging market conditions. If they have used assumptions in developing the figures, are they representative of the current market and conservative to allow some leeway?
The franchisor may give you a draft business plan with typical financial projections however this is only a starting point for you to build your own forecasts taking into account the local market research you’ve done in your chosen location. When assessing the financial commitment you are looking to take on it is essential to have a good understanding of when the business is likely to reach break-even and when you should expect to see a return on your initial investment.
Your financial projections will include a profit and loss forecast to demonstrate that the business is likely to be a worthwhile venture for you as well as a cash flow forecast, broken down monthly, which will help you establish how much money you will need at the beginning so you do not run out of working capital along the way. Additionally a projected balance sheet will give you a snapshot of the financial health of the business at the end of the first year. Together these three documents should give you a clear understanding whether the investment in your chosen franchise makes financial sense.
You should also acquire a copy of the franchisor's filed accounts from Companies House and ideally if you know the company names of some of its franchisees you should research their trading history as well. These documents are public record, which means that they can be readily obtained and will give an insight into the recent trading performance and the viability of the business. Your accountant can help you understand the figures if you need some guidance.
Of course the likely financial returns are not the only consideration when investing in a franchise, as being your own boss and enjoying a better quality of life can be more of a priority to some people. It is essential that you invest some time at the outset researching and understanding the financial aspects of the business opportunity to avoid the possibility of losing your hard-earned savings should the business fail.
Why banks like franchising
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
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
Article by Richard Holden, Head of Franchising, Lloyds Banking Group
Applied for a loan recently? Had your request turned down?
If this resonates with you then read on. If you’ve had an application for finance declined then you should ask the lender for a detailed breakdown as to why they’ve rejected your request. This will help you establish whether you could improve your application and potentially appeal the decision.
Lending applications can be rejected for many reasons however the same issues crop up time and time again. With some insight into the common mistakes to avoid you can prepare a much more robust business case for the bank to consider.
Adverse Credit History
If you are applying to your own bank they will review the recent conduct of all the accounts held with them. Regular unauthorised excesses over agreed facilities or returned items are likely to damage your chances of a successful lending application.
If you are applying to a new bank they will request copies of your personal and business account bank statements to review how your conduct your accounts. Excessive transactions for credit cards, finance companies, pay day lenders and online bookmakers are likely to attract the attention of the bank manager and possibly raise doubts about your ability to take on an additional financial commitment.
A lender will carry out searches with credit reference agencies on the owners and the business itself as a part of their assessment. It is sensible to check your records with the various credit agencies before applying for a significant loan, if you have any doubts about your credit record. Mistakes can happen and you should apply to get your file changed if you feel it is inaccurate.
Poor Business Plan
A great business plan should be punchy, with relevant information and will grab the bank manager’s interest, however far too many plans I see fall down. Commonly, the plan does not provide enough detail to demonstrate that there is a viable business which can meet the financial commitment being requested.
The business plan should give the lender confidence that you’ve undertaken the necessary research and will be able to operate the business successfully in your chosen location. Well established franchise brands have the advantage of a track record proven over time and the franchisee receives initial training and support throughout the life of the business. Banks that specialise in franchising do take the strength of the franchise into account as well as the investor.
Inaccurate Financial Projections
It is the franchisee’s responsibility to adapt the draft figures provided by the franchisor to ensure they take into account the local market conditions. Frequently template financial forecasts are not been adjusted and the franchisee doesn’t understand them. When the bank manager challenges the figures the franchisee is unable to confidently answer the questions and explain how the business will be able to service the financial commitment they are looking to take on.
Sales projections that are out of line with what other franchisees in the network are already achieving will be questioned, so it is prudent to ensure the revenue figures presented to the lender accurately and conservatively represent the business opportunity.
Sometimes people try to combine the profit and loss projection and cash flow forecast into one spreadsheet. They are two separate documents providing different information and both are required to fully assess a business lending proposition.
Banks may stress test the projections to analyse how the business will stand up under less favourable economic conditions. The stress test is designed to determine whether a business has enough capital to withstand the impact of adverse developments and still meet its financial commitments.
Insufficient Capital Available
Any lender will expect the owner to invest some of their own savings into the business. Exactly how much personal capital stake is required depends upon the strength of the franchise brand. For well-established franchise opportunities most major banks will consider lending up to 70% of the start-up costs, whilst for newer, less established franchise brands that figure may be lower.
The personal contribution should come from savings and not be borrowed from a credit card, personal loan or even a family member. The bank manager will ask to see evidence of your savings before assessing the loan request.
Out of Date or Weak Trading Accounts
If you looking to raise funds to develop an existing business, the lender will want to see the latest trading accounts for that business to show that it is trading profitably. The bank manager will also look at the latest performance and compare the figures to previous years to identify whether the business is expanding, stagnant or declining.
It will concern the lender if the latest accounts haven’t been filed on time or if you are unable to produce up to date management figures for your business when requested. The bank manager may well be apprehensive if there are little or no profits retained within the business. The recent trading history of an established business is a key assessment tool for any lending request and therefore up to date financial accounts are essential.
No Security Offered
Typically, if a bank is going to finance a business they will consider funding up to £25,000 on an unsecured basis however for larger applications it is likely that the bank would want some security. This would usually be in the form of a legal charge over a residential property with sufficient equity although other assets may also be considered.
Some lending applications fall down because the business owner is not prepared to secure the lending against their personal assets. If you expect the lender to back your business then you need to be prepared to demonstrate your confidence in your business and your own ability.
The Government backed Enterprise Finance Guarantee Scheme may be available to businesses that have a strong business plan but lack the security that a bank would usually require.
Personal Income and Expenditure Issues
Lenders will review the ability of a business to provide enough income for the owner to live on and service any borrowings they have, particularly in the early years. Some people may have a supportive partner who brings in a wage. This additional household income reduces the franchisee's dependence on the profits of the business.
It is important that a franchisee provides a detailed breakdown household income and expenditure, demonstrating just how much money needs to be taken out of the business to meet all personal commitments. The personal expenditure breakdown will be cross-referenced to your personal bank statements to ensure that it is an accurate summary of your financial position.
Someone who needs to draw a substantial income from the business from the outset is likely to put a considerable strain on the business. It won’t take them long to draw out the equivalent to what they originally invested as their capital stake and the bank wouldn’t be comfortable with that risk profile.
Requesting finance from the wrong person
With over 900 franchise brands in the UK, don’t assume that your local bank manager knows everything about the particular franchise you are interested in. Always approach the bank’s Franchise Unit is the first instance for expert advice and professional guidance.
The bank’s franchise team can advise you about their stance towards financing the franchise you are looking at and you will be able to write your business plan according to their guidance.
Avoid these common mistakes and you will be in a much stronger position to secure the financial backing you are looking for from your lender.
How a bank manager assesses a finance request
Article by Richard Holden, Head of Franchising, Lloyds Banking Group
Financial assistance for franchises is readily available from banks that specialise in the sector. The bank will be looking for a strong business proposal however what is it that the bank manager will be looking at when you give them your business plan?
Banks use a variety of tools to evaluate funding propositions and most lenders will use a mix of Credit Scoring and checking your credit file with credit reference agencies to assess the funding risk. Bank managers will usually base their lending decisions on the traditional canons of lending. These are followed not only in the interest of the bank, but also of the customer who can take comfort that full and fair consideration has been given to their application for financial support.
It is important that you are aware of the factors your bank will consider when making a lending decision so that your business proposal will hit the mark. When you present to a bank you need to provide them with enough information and reassurance so they can mentally tick off each element of their aide-memoire and hopefully agree your proposal.
Banks lend money when there is a good chance they will be repaid, so firstly the bank manager will want to establish trust in you. They will look at your integrity, background and reliability. Your skills, experience and track record will help to demonstrate your ability to repay the financial commitment you are taking on.
Previous industry experience may not be necessary, particularly when you are investing in a franchise, where you will receive initial training and support throughout the life of the business from the franchisor. Complementary skills, such as managing a team, selling skills, building strong customer relationships and being well organised are often more important to a franchisor than working in the same sector before.
Ensure that you communicate your key skills and attributes to the bank manager so they have a picture of how you will be able to operate your chosen business successfully. Your track record, financial resources and suitability to run the business are points the lender will consider. A franchisor will also look at these to ensure that you are suitable franchisee.
The bank will want to establish whether the amount you are looking to borrow is suitable for the purpose. Will you be under-capitalised and likely to run out of money or are you looking to borrow too much, putting unnecessary strain on the business from the outset.
You should be prepared to invest your own savings into the business as the bank would expect you to contribute some money yourself. For well-established franchise brands most banks will consider funding up to 70% of the total investment including working capital however for newer, less established franchise opportunities you will need to invest more personal capital yourself.
Investing in a tried and tested franchise helps with credibility, although the bank will want to consider whether there is sufficient demand for your product or service in your chosen location. The borrower should also have a contingency reserve of funds to fall back on in case the business takes longer than expected to get off the ground.
The repayment source of the lending needs to be established at the outset. Repayment will usually come from trading profits and this is where your projections will be thoroughly tested by the bank. Historic trading figures and up to date management accounts are essential for existing businesses.
New start-up businesses will be based upon realistic and conservative projections and will be open to challenge from the bank manager. A franchise specialist bank is likely to have experience of existing franchisees that bank with them and they have the ability to draw on that knowledge to consider the likely repayment capabilities.
Your financial projections will include a profit and loss forecast to demonstrate that the business is likely to be a worthwhile venture for you as well as a cash flow forecast, broken down monthly, which will help you establish how much money you will need at the beginning so you do not run out of working capital along the way. The bank manager will want to understand what assumptions have been used in developing the forecasts.
When assessing the financial commitment you are looking to take on it is essential to have a good understanding of when the business is likely to reach break-even and when you should expect to see a return on your initial investment.
Banks will assess the risk and decide whether security is required. For lending applications below £25,000 a bank will usually consider funding on an unsecured basis. For larger amounts, the bank is likely to look at security to cover your financial commitment, which will typically be a legal charge over a residential property with sufficient equity. Other forms of personal assets may be considered.
If you have a strong business plan but don’t have any personal assets to support the lending then the bank may be able to consider financing your plans using the Government backed Enterprise Finance Guarantee Scheme. Speak to the bank’s Franchise Department for guidance as to whether you would be eligible for this scheme.
The primary source of repayment will be the cash generated by your business and the available security is just the bank’s safety net.
Banks with specialist franchise teams, such as Lloyds Bank, are far more likely to offer the professional support you need when assessing your finance plans to purchase a franchise. For expert advice always approach the bank’s Franchise Department in the first instance, rather than your local bank manager, who may know little about the brand you are investing in or indeed franchising in general.
Improving your credit rating
Article by Richard Holden, Head of Franchising, Lloyds Banking Group
If you’ve had credit difficulties in the past, what can you do to get the backing of a bank to support your franchising plans?
Your credit history can affect your ability to borrow money from a bank however a poor credit rating can have a far wider impact on your ability to get store credit, a mobile phone contract or even pay insurance by monthly instalments.
It is worthwhile checking your credit report to ensure that the information held on your file is accurate. Mistakes can happen which may restrict your chances of obtaining credit so it is important to regularly check the records and definitely do this before making any major application.
There isn’t just one credit file and don’t assume that all your files will be identical. Your credit files are held by Experian, Equifax and Callcredit. You have a statutory right to check your files with all three credit reference agencies.
Here are some of the things that could have a detrimental influence on your credit rating:
- Significant existing debt
- Multiple recent credit applications
- Payment arrears
- Late payments
- Default information
- County Court Judgments
- Financial association with someone who has a poor credit history
- Not on the Electoral register
- Credit card accounts which aren’t being used
- Frequent changes of address
Clearly it is best to avoid doing anything that could adversely impact your credit history. Don’t worry if your credit rating isn’t in the best shape because there are simple steps you can take to improve your chances of securing the financial backing you require.
First step is to stop applying for credit until you’ve sorted out any problems. Every time you apply for credit it leaves a footprint on your file. You should fix any mistakes on your credit file by complaining to the relevant credit reference agency. They have 28 days to investigate your concerns and either remove the error from the file or explain why they may disagree with you.
Get on the electoral register if you haven’t already done so and cancel any unused credit cards. If you have defaulted on any credit agreements in the past don’t bury your head in the sand; speak to the lender and come to an arrangement to settle any outstanding debt.
Moving forward ensure that you make all payments on time by setting up direct debits as this shows that you are a responsible borrower. Often these direct debits just cover the minimum payment, so if you want to clear your debt quicker you’ll need to make additional payments but at least you’ll have the peace of mind of knowing you won’t miss a payment.
Whilst having too much debt is to be avoided, if you have never borrowed before this can also work against you. If you have never had a credit card or a loan, lenders cannot review your track record to establish whether you are capable of sticking to a repayment plan.
You may need to build your credit history before applying for any major financial commitment. There are credit builder cards you can apply for which are designed to help demonstrate your repayment history and there is no interest to pay provided you repay the card in full each month. Obviously if you have an unused credit card you can start using that to rebuild your credit record rather than applying for a new card.
If you’ve had joint finances and have split with your partner, then ensure that you financially de-link as soon as your finances are no longer linked to stop their credit history affecting yours.
County Court Judgments stay on your record for six years and information about applications last for one year so it may benefit you to hold off applying until old issues drop off your file.
Lenders with a specialised franchise department, such as Lloyds Bank, are the best bet for funding the franchise opportunity you are looking at. They will have a team of trained managers who understand franchising and are likely to have a track record of funding existing franchisees in the brand you are looking to invest in. If you are finding it difficult to get credit, you may find it beneficial to apply to your own bank as they already have an established track record with you.
How to avoid identity fraud
Article by Richard Holden, Head of Franchising, Lloyds Banking Group
Identify theft and fraud is a rapidly growing problem in the UK and it can have a devastating impact on unsuspecting individuals who apply for finance. Identity fraud is where someone uses the identity they have stolen to commit a crime, such as applying for credit with the stolen identity. It can take a long time before you spot that you are a victim of identity fraud, and it can also take a long time to recover from it.
Anyone can be a victim of fraud, but you can take a few simple steps to protect yourself.
- Shred or destroy documents that contain personal information before throwing them away
- Read all bank and credit card statements regularly to check for suspicious transactions
- Report theft as soon as possible
- Never disclose your personal information to cold callers without verifying them
- Don’t disclose too much personal information on social networking sites
- Register to vote at your current address
- Redirect your mail via the Post Office if you move address
- Never write down or share passwords or PINs
- Don’t use the same password for logging into all your sites and change them regularly
- Check your Credit Report regularly
By following these simple steps you can prevent fraud destroying your personal credit record. You should start addressing past problems straight away so that you will be in a position to apply for financial assistance from a bank when you find the right franchise opportunity for you.