Starting your own business as a new business is both exciting and daunting. If you are thinking about adopting one franchise and need financing, you might be surprised at how easy it is. Knowing how to finance a franchise is just the first step.
What is a Franchise?
A franchise is a business model in which several smaller companies operate under the established name of a larger company. The franchisee sells products and services through a defined marketing strategy, with all aspects of each franchise reflecting the parent company. The franchisee takes care of the day-to-day business and shares in the profits.
Franchising offers reduced start-up costs by giving you access to the proprietary knowledge, trademarks and processes of an already established and successful company. Financing a franchise business is easier than you might think.
Are franchise business loans different from other business loans?
From the outset, lenders view franchises as a more reliable option than independent business startups. This means you are better positioned from the start. Franchise loans allow you to borrow between 50 and 70% of the value of an existing franchise or up to 65% for a completely new franchise. If you offer a residential property as security, you may even be able to borrow up to 100% of your start-up costs.
Franchise loans work largely like regular business loans, the biggest difference is that you can typically borrow more. This is because the parent company has already done much of the work to demonstrate a successful business model. For this reason, lenders view franchise loans as significantly lower risk.
In both scenarios, the features and interest rates tend to be similar, only your creditworthiness is different. The term of your loan depends on the term of your rental agreement and/or the length of the contract with the franchisor. If you want to offer a property as a guarantee, you may be offered a longer loan term.
When applying for a franchise loan, low credit or bad credit loans are generally not available.
What type of franchise do banks prefer?
Not all franchises are considered low risk by banks and lenders. It is an ever-evolving situation and a franchise that is favored now may not be available within a year. Banks’ ranking preference of franchises is based on four key considerations:
- The number of franchises already opened. Banks like to see growth and between 30 and 40 already successful franchises from the same franchisor.
- Call. Public opinion and awareness are important. If your proposed franchise has been exposed to negative press, you are less likely to get a loan.
- Key Performance Indicators (KPIs). These are set by the franchisor depending on the type of business it operates and the expectations it expects from its franchisees. The bank will review these and check whether they are solid financial goals.
- Total exposure. Banks are happy to offer their financial offers to franchisees from various industries. Reducing their risk if problems arise in a sector. For this reason, they tend to limit their weighting per sector annually and refuse loans when this limit is reached.
How to finance a franchise business
During your loan application process, the bank or loan specialist will take steps to determine the amount they are willing to borrow. They determine how a franchise should be financed by:
- Evaluation. This is an independent assessment of the market value of the franchise. The rating of a franchisor is not taken into account.
- If you are taking over an existing franchise, you will be asked to provide supporting documentation about the business’s finances, such as business tax returns, profit and loss statements, and business bank statements.
- EBITDA or earnings before interest, taxes, depreciation and amortization. This analyzes the profitability of a company compared to its competitors in the same industry. Providing a clear indication of the company’s earnings potential.
- Business plan. Before you apply, you will need a comprehensive business plan that details all aspects of the business. This should include cash flow forecasts, ongoing costs and how you plan to keep your business thriving and profitable. The plan should also cover financing beyond the loan amount and outline how you will use your equity.
- Experience relevant to the franchise you want to open. For example, if you want to work in hospitality, management or frontline work, expect to have three to five years of work experience in these industries. If you don’t have these skills, the bank may see you as a higher risk of a failed business venture.
The amount you can borrow depends on what the lender deems sufficient to cover associated franchise fees, staff training, store equipment, store inventory equipment, and other start-up costs. Be aware that there is an expectation that you will have additional capital to invest in the business. This applies to both the start and difficult times.
Still unsure how to finance a franchise? Fill out a Request your inquiry form from the experts at ALC Commercial today or call us on 1300 886 996.
