Financing a business, especially a franchise business, goes beyond just having some capital to start – you need to factor in everything from start-up capital to ongoing financing; from hidden costs to expansion funds. The financing of a franchise is always a huge hurdle that needs to be overcome through thorough research and careful planning. This is the one area of your business that needs a level head, clear thinking and to a large extent, a realistic approach. Don’t be afraid to ask your prospective franchisor, your financier and yourself these pertinent questions.
Ask the Franchisor….
How much will my total investment cost me?
This is probably the most important question as not all franchises calculate this cost in the same way. Some include certain costs, while others only add them on later. Knowing what makes up your total investment is important from the outset as this will influence which franchise you choose and whether you are able to afford the business. The total investment is the complete cost of starting up the franchise operation and should include the up-front fees, set-up and establishment costs and start up stock.
What will my monthly expenses consist of?
In franchising monthly management fees (or royalties) need to be factored into the monthly expenses. These are usually calculated on the basis of a percentage of the franchisee’s gross sales of turnover, with some franchisors working on a fixed levy fee. In addition to the monthly management fees, most franchisors ask for a contribution to a national or regional marketing or advertising fund which is pooled and used for the benefit of all franchisees. You can then add these figures onto the monthly running costs of the business, which consist of employee salaries, utilities bills, transport, stock purchases and other expenses related to the business.
How is the lease agreement structured?
Deciding on premises from which to operate your franchise are usually in association with the franchisor who has vast experience in dealing with landlords. Make sure that the lease price is in line with the standard franchise model and well within your budget allocation. If possible link the lease term for the same period as the franchise agreement as renewing the one while still bound by the other could lead to administrative and financial problems.
How are projections calculated?
Different franchises use different models to arrive at their projections for a franchisee. Some use a benchmark that has been achieved by the outlets, on average, while others make forecasts based on that particular site, taking specific variables into account. Good franchisors provide franchisees with projections for the first three years as well as actual examples of what a typical income statement should look like.
What other investments will I be expected to make?
In a franchise contract, provision is often made for the refurbishment of stores at regular intervals. Equipment has a life span and franchisees are expected to replace it from time to time. All this not only costs money, but the franchisee may have to close shop for a month or two, which impacts on income. It is important to know how often this happens and what the associated costs are.
Ask the Financier…
What will the banks be looking for?
The banks have a cautionary approach to lending and will look at both the person they are lending to and the business that they are financing. From the outset, both the franchisor and the bank will require that you have between 40 and 60% own cash to invest into a franchise. Fortunately, most of the major banks have dedicated franchise desks and they are familiar with many of the leading franchise brands so prospective franchisees are often considered more favourably than a conventional start up business.
How can I ensure getting a loan?
To obtain finance, a prospective franchisee needs to convince the bank or investor that he will be able to pay the money back. Therefore, he needs to be able to clearly express his requirements in writing and in financial terms. This means he has to provide a pro-forma balance sheet and conservative but realistic estimates in terms of cash flow and income statement projections in a well-prepared business plan. He also needs to determine what level of debt the business is able to comfortably afford in terms of monthly capital and interest repayments, leaving sufficient margins for unforeseen circumstances, such as interest rate increases and hidden expenses.
How much working capital will I need?
Working capital is a vital component of any business start-up and after the total investment is calculated, adequate working capital should be added to ensure that the right amount is available before going into business. This back-up capital is to cover any cash shortfalls while getting the business off the ground. Things like staff salaries, rent, stock replenishment and running costs needed during the initial few months. It should also provide for seasonality where customers’ demand for products or services may vary depending on the time of year or from a downturn in business.
What other financial solutions will I need?
Aside from providing loan finance and funding working capital requirements, the bank should also play an important role in providing convenient transactional banking products and services to assist with the smooth running of the franchised business. Sound cash flow management practices should be established at the outset, as cash flow is undoubtedly the life-blood of any business.
Do I understand what I’m getting into?
You must understand very clearly what you are letting yourself in for, the legal obligations you are undertaking and the risks you are taking from a financial perspective. Your business plan must become your bible and you must understand and control every part of the business.
How will my standard of living be affected?
With any business start-up, until the venture takes off, cash flow may be constrained in the first year of operation. Be prepared to tighten the belt and even forfeit an adequate salary for a few months to make sure the business has a good head start. Be prepared for this sacrifice – both from a financial and emotional point of view and get the support of family and friends to help you through this stage of the business venture.
Am I ready to take the plunge?
After all the pros and cons have been weighed up, it is time to sit down and decide whether you can afford the business and whether the business can afford you in terms of the salary you eventually want to take home. Acknowledge that sacrifices have to be made and once you decide to go the franchise route commit to it with all your heart and soul – and you will be successful!
Latest posts by FASA Franchise Association South Africa (see all)
- A damning report released on South African tobacco industry - 17th October 2019
- Cash in on events building up to the festive season - 17th October 2019
- Services SETA Discretionary Grants Call for Applications - 17th October 2019