Grant Thornton New Zealand
how to STRUCTURE AND FINANCE a franchise investment

When you are looking to buy a franchised business, how you actually pay for it is key. It will affect not only what you can afford, but also what return you may make from the business. The questions you need to ask at the beginning are:

•      How much can I put in myself?

•      How much should I raise externally?

The total investment in your new business will include not just the franchise fee but all the set-up costs including training, equipment, signage, vehicles, premises fit-out and so on. A portion of these costs will be covered by your available funds (money in the bank), but if, like most people, you don’t have the full amount needed then the difference will need to be made up from other sources. These other sources could include:

•      Bank finance (see Cat Feaunati’s article Raising the Money at www.franchise.co.nz).

•      Vendor finance (money left in the business by the seller).

•      Customer financing (finance provided by key customers).

•      Family or friends.

Your ability to borrow from a bank will be limited by the security being offered and your (or the business’s) ability to service the debt – to make the loan repayments on time. Banks are not generally willing to lend solely on the cash flow the business will generate, so other sources of finance such as family and friends may need to be considered.  No matter where funding is sourced from, the business must be able to repay borrowings from cash generated by the franchise.

Funding is still proving difficult for SMEs, although if you choose a well-established and proven franchise you may find it easier. The Franchise Association of New Zealand (FANZ) has recently taken up suggestions to champion a Small Business Growth Scheme which would fill the gap through the government underwriting a portion of the loan. The benefits to New Zealand would be stimulus to small business, job growth and increased tax revenue. Such a scheme could be of considerable value, although it would take some time to put in place – too long for current business buyers. If you are interested, contact FANZ for the briefing documents.

Choosing The Right Structure

Your business can be set up in one of a number of ways legally, from operating as a sole trader or as a partnership to registering as a limited liability company. Which structure you choose – and who owns the structure – will depend upon your answers to the following:

•      Does the franchisor place any constraints on how I, as a franchisee, can structure my investment? For example, do they insist that all franchises are held by limited liability companies or are granted to one person only rather than both parties in a husband-and-wife team?

•      Who do I want to participate in the equity of the investment? Who is putting money into the business, and should they have any share of the ownership?

•      Will my investment make losses in the short term? Most businesses do not make money from day one and some structures allow for this better than others (see below).

•      What are my long term objectives for the business?

•      How will the tax consequences of my investment structure impact the investors?

•      How important is limited liability to me? A limited liability company may allow you to remove your own personal financial affairs from those of your business, which could be important.

•      What is my strategy to exit the business? Everyone moves on eventually.

You need to weigh up all these issues with the assistance of your professional advisors. In most cases, a limited liability company will be a suitable vehicle for franchisees because it is simple to set up and many people already have a reasonable working knowledge of how they operate and the compliance obligations.  However, if initial losses are anticipated, it may be better to establish a “look through company” (LTC).  A LTC is a hybrid vehicle which provides all the safety of a limited company, with the tax consequences of the company flowing through to the shareholders.  While this adds a layer of complexity, the ability to offset your company losses against your personal income can have substantial benefits (this, of course, depends on you having any personal income other than from the business).

Who should be the shareholder or shareholders? This is another thorny issue. Do you want to own your shares solely, jointly with your spouse, or through a family trust?  Each option has different tax and legal consequences, so seek the views of your accountant and your lawyer. Tax is an issue close to most investors’ hearts and while the trust income tax rate and the top personal tax rate are both 33% currently, you only need to go back a year to find they were different – divergence in the future is only a case of ‘when’ not ‘if’. The company tax rate is currently a healthy 28%, but this will not apply if you elect to be a LTC. In addition, if you need to access the money in the company to live day-to-day, you will end up paying the top rate.

For all these reasons, structure and finance are two things which you must think about – and take advice on – up front. If you get them right, you will be able to concentrate on running your new business free of these worries. If you get it wrong, you may find it a considerable distraction and putting it right could be impossible, expensive or both. 

This advertorial is taken from Franchise New Zealand magazine Volume 20 Issue 4 

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