Westpac - Get The Right Funding

In the last issue, we looked at what you are paying for when you buy a franchise and how much it should cost, both initially and on an ongoing basis. That is always the first consideration from a financial point of view when buying a franchise: the next is to work out whether you can afford it.

When they reach this stage, a lot of people work on the principle of ‘How much can I borrow?' But this is actually the wrong question to ask. If you want to make a sound investment, what you actually need to know is, ‘how much can the business afford while still delivering a decent living and fair return on my investment?' As you will see, this is a completely different question. In order to work out the answer, there are a number of stages to go through.

1.      How much money do you actually need to buy the franchise you are keen on? Franchise adverts can be very confusing because franchisors do not all use the same assumptions. If the capital requirement is listed as between $90,000 and $120,000, what is included in this price? Does it include the franchise fee and, in the case of a new outlet, the fit-out? Does it include equipment, legal costs and accounting fees? Does it include training costs, or the costs of travel and accommodation and living costs while you are in training? Is the amount quoted the total cost of your investment or does it only reflect the cash equity required? Does it include working capital? (see point 4 below)

2.      Can you fund against the future cashflow of the business? This is often the case when setting up a new franchise from a well-established franchise system, and it's an important point - it could lower your equity requirement and mean you could afford a much larger business than would be the case with setting up a normal small business. The level to which you can fund against cashflow would be determined by the debt servicing capacity of the business and the reputation and business model of the franchise system in question. Some franchises have special packages available from preferred banks.

3.      What is the appropriate term for the funding? Try and match the funding to the asset and take into account when it needs to be replaced. In the case of a retail outlet, for example, you would want to ensure that funding is fully repaid by the time your store needs a refit under the terms of the franchise agreement or the lease. Normally, short-term funding would not be suitable to fund the business although it would be more appropriate for working capital.

4.      How much working capital will be required? This simply means the amount of cash you need to operate the business effectively. Working capital is used to pay the bills - for example, wages and phones - and sometimes to carry stock until the business generates some income. Very few businesses can operate without working capital and often, as the business grows, so the amount of working capital required grows too. This is an area where your franchisor, as well as your banker, should be able to help you plan ahead.

5.      Do you actually understand the basic finances of your new business? Getting professional advice is essential, but make sure you understand the figures - and what they actually mean - yourself. Ask an accountant to help you create cash flow projections that will assist you in recognising what makes the business profitable and why certain levels of funding are required. If you understand these factors and keep an eye on them as your business progresses, you increase your chances of success considerably.

Use Your Banker

Getting the answers to all the above questions means talking to your chosen franchisor, your accountant and your bank. Just as it pays you to consult an accountant and a lawyer who have experience in franchising, so it will pay you to talk to a specialist banker - and a specialist bank. Does your everyday bank have a franchise department? Do they have franchise knowledge, benchmarking experience and a strategic relationship with your chosen franchise system?

A generalist business manager will normally require 100% security on borrowing; a specialist franchise banker can often arrange initial lending based on their real knowledge of the business model and benchmarking. A specialist can also add real value to your business through arranging appropriate ongoing financial services: for example, franchise-specific transactional and personal banking packages. Having such packages also means that every time the franchisor negotiates more benefits for the system, you will automatically qualify as well.

Finally, don't forget to ask what deals may be available for your business's day-to-day transactional needs. A lot of people concentrate on the initial lending but forget about the ongoing banking services that directly influence their bottom line. Putting the right package in place at the beginning can remove one source of worry while you are growing your business and actually help you get where you are going faster.

This article is taken from Franchise New Zealand magazine Volume 16 Issue 4

Contact details for Westpac

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