Westpac - Finding Answers On Funding

Many of the questions received by the Westpac franchise team from potential franchisees cover similar ground. Here are a few answers that you might find helpful.

Q Why is a franchise business more attractive for someone wanting to go into a new business from a funding perspective?

A The better-known franchises usually have strong systems and a strong brand that lower the business risk considerably. As a result, a bank with a specialist franchise unit like Westpac is often prepared to lend against the new franchised business based on the record of other existing franchisees.

This means that potential franchisees can secure part of the investment against the assets and future cash flow of the business and can therefore possibly afford a much larger business than would otherwise be possible. It can also be an important consideration for immigrants who do not know the business environment and have no credit history in New Zealand.

Q  How much can I borrow?

Your aim should be to borrow the minimum necessary in the most cost-effective way while not leaving yourself short of the finance necessary to fund, say, working capital. The basic question is: how much can the business afford to repay (‘debt servicing', in banker speak) while still allowing you a decent living? You must take advice from an experienced accountant to work this out, and will need to include any tax implications in making the calculations.

Your bank will look at how much money or equity you are prepared to put in yourself (about 50% is normally required but it can vary), the security offered, your financial record and proven business acumen or other factors if applicable.  In certain exceptional cases, with well-known proven systems or where the equipment or stock lends itself to this approach, the bank may also do some debenture lending or cash flow lending. This can reduce the total security required. Because of the many variables involved, this will be judged on a case-by-case basis.

You may also need more than a simple loan. The right mix of finance may include: short-term working capital (e.g., an overdraft facility); medium-term business finance (e.g., a term loan); long-term finance or equipment leasing. The bank would look at the term of your franchise agreement, the debt servicing capabilities of the business and the particular needs of the industry in determining the best mix of financing. In some cases, leasing vehicles or specialist equipment can reduce the actual initial borrowing required.

With proven systems the perceived risks are lower and the loan requirements are often more relaxed. If you consult a specialist franchise banker you can expect that your they will have knowledge about the franchise systems in which you are interested.

The vital steps are: determine how much you need; how much you can afford; and involve your banker in the decision-making process on the right amount and mix of the financial solution that is required. If you familiarise yourself in advance with the process and information required to obtain finance, it will save a lot of time and effort. It will also help you to ask the right questions when buying a business, and put you in a much better position for making a decision when the time comes.

Q Can I have 100% financing?

When purchasing a profitable existing business, or setting up a franchise outlet from a strong franchise brand, you can often fund a percentage against the business cash flow and assets and make your contribution in the form of equity in property. This could result in 100% funding. The business lending (typically a business term loan of three to five years) would be against the business itself (using a GSA - general security agreement) and would be more expensive than the fully-secured part of the lending. How much more costly would depend on the risk. Vehicles or equipment can also be purchased through equipment finance or leased, lowering the initial capital requirement further, but this tends to be more expensive.

The main factor determining if 100% lending is possible would be whether the business can afford it. Under-capitalisation is one of the greatest causes of business failure. Even the best business can be brought down if it is struggling under the burden of too much borrowing, which is why it pays to be careful.

On the other hand, wisely-structured borrowing can enable you to take up your dream opportunity, repay the loan and enjoy the income you earn. The important things to remember are:

1. The loan should be capable of being repaid within the term of the franchise agreement, or, if not, this should be taken into account when selling.

2. The level of payments must be affordable.

3. Get the right mix of short and long term funding. Discuss your future business plans with you franchise banker. If you want to open a second franchise in 18 months, the funding structure to make it possible may need to be very different.

4.  Always take appropriate legal and financial advice.

Q Is buying or setting up a business from a well-known franchise brand a guarantee that it will be financially successful?

While buying a well-known brand with strong systems will go a long way towards putting you on the road to financial success, it is not in itself a guarantee. The profitability of individual franchises in a franchise system can differ a lot. In the case of a retail franchise, for example, factors like location, competition, the rent paid as a percentage of total turnover, wages and cost control will influence how profitable any particular franchise is.

Better management, good location and higher turnover and Gross Profit margin can make one franchisee more profitable compared to others in the group. Paying too much in rent, poor cost control, not making use of collective purchasing benefits, bad or non-existent local marketing, lack of owners involvement, shrinkage or strong competition are all factors that could lower business profitability.

There are no guarantees in business, even in franchising, but if you choose a good system, apply it well, take the advice of your field consultants and benchmark against others in the system then you are increasing your chances of success considerably.

Always Ask

The above are examples of just a few of the issues that potential franchisees typically ask about. If you're looking at buying a business, you should never be afraid to ask questions (see page xx). Always feel free to ask your accountant, banker and the franchisor about any issues around the funding and expected financial returns. After all, your future and livelihood depends on getting the right information.

This article is taken from Franchise New Zealand magazine Volume 17 Issue 2

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