You’ve decided you may be suited to starting a franchise, but you have no idea how to finance it. How do you start? Cathryn Hayes, Head of HSBC’s dedicated Franchise Unit, gives some advice.
In broad terms, franchising is a safer option than going into business on your own. A franchisee should have a tried and tested format to follow, training and support from their franchisor, and a network of fellow franchisees to speak to – so although franchisees own and operate their own business, they are not doing it alone.
A good franchisor will encourage and help their franchisees with business planning, both at the outset and on an ongoing basis – helping the business to get off to a flying start and continue to develop.
Many small business owners are just too busy to look at what is happening in the market place, what competitors are up to, how customers’ needs might be changing – but a good franchisor will be looking at research and development, helping their network of franchisees to keep ahead of the game.
All this support means that banks are going to be much happier to lend to a start up franchisee.
But before you are ready to talk to the bank about borrowing money to start your franchise, you need to establish how much funding you will need.
There are a number of costs which need to be taken into account, depending on the type of franchise – the initial franchise fee is really only part of the picture. For instance, an owner/operator franchise may need to purchase or lease a liveried van and they will need to fund opening stock.
A retail franchise will incur the cost of leasing premises and any refurbishment requirements as well as shop front, branding, fixtures and fittings. Franchisees would also need to think about professional charges related to the property transaction, such as lawyer, architects and surveyor’s fees, as well as insurance. If employing staff, there may be recruitment costs; the franchisee may also need to provide uniforms. There will be marketing costs involved with an official launch of the business.
Working capital will also be required – what you need to live on prior to the business generating cash flow and profits. Find out whether training costs are included in the initial franchise fee; if not, these will have to be factored in.
Once up and running, you will pay the franchisor ongoing management services fees – this may be a percentage of your turnover, a mark up on products provided or a fixed monthly or weekly fee.
You should do your homework, and fully research what you will be getting for your money both at the outset and once your business is established.
For an established franchise, most of the major banks will lend up to 70% of the start up costs, for new franchises the figure will probably be around 50-60%. You will pay the borrowed money back over a period, maybe 3 or 5 years, depending on circumstances.
The first step is to establish how much money you can invest in the business – what can you afford to invest? Have you got savings, can your family help?
Prepare a full list of your personal expenditure: mortgage, hire purchase, household bills, and so on. This will show how much money you will need to take out of the business in order to live. Consider what security you can give to back up your loan, you may be a life policy with some value, or have equity in your home.
Start preparing your business plan – this is a vital document to obtain finance from the bank. Your chosen franchisor will often help you with this. As part of your business plan, you will need to prepare cash flow forecasts for the first couple of years of the business. Your franchisor will help, but you need to be sure that you understand the figures, what they are based on and how much you will have to turnover in order to break even.
It is important to consider the financial implications carefully before buying a franchise. You are entering into a long term commitment and need to get the finance right at the outset. Don’t do it on a shoestring, but don’t borrow more than you can afford to repay.
The following outlines a bank’s basic approach to assessing a request for finance and should provide a useful insight into the information needed before a financial provider will agree to lend the amount requested.
Person – your bank will look at your background and reliability; your training and qualifications to help establish your track record, financial resources and suitability to run a business. A franchisor will also look at this to ensure that you are suitable franchisee.
Amount– How much you’d like to borrow, how is it going to be used and how it will benefit the business. We will also consider whether there is sufficient demand for your product or service (the fact that you will be investing in a tried and tested franchise format helps here). How much you are prepared to invest in the business? Normally you are expected to contribute towards the total start-up costs from your own resources, but it is important to get the balance right. Often new start-up businesses underestimate how much they will need to borrow to make the business successful, therefore it is important to be realistic when presenting your business plan to the bank.
Repayment– It is not in your bank’s interest – or yours – to lend money unless it looks likely that you can repay it. Therefore your bank will need to understand from the cash flow forecast how you can afford to repay the loan. What assumptions have been made? What level of sales are needed to break-even and is it achievable? Is there a contingency plan for any setbacks?
Security – banks must assess the risk and decide whether security is required. This will depend on an evaluation of your business as a whole – the prime source of repayment will be cash generated by your business and no amount of security will ever be acceptable if we feel that your business is not viable. The last thing we want to do is realise any security – we would much rather see a successful business continue to trade. If no security is available, we may consider finance under the Government’s Enterprise Finance Guarantee, if the business is eligible. This is a government backed scheme to guarantee 75% of borrowing where security is not available and where lack of security is the only bar to the bank lending money.
With the full information provided, the majority of lending decisions could be made within 48 hours of the date of the meeting, subject to certain criteria.
This article is written by Cathryn Hayes, Head of HSBC’s dedicated Franchise Unit. The unit has been going for over 25 years and continues to work closely with the British Franchise Association (bfa) and its members in the development of ethical franchising.
HSBC’s Starting a Franchise guide has more information on the planning and research required to start a franchise. Free copies are available to download from www.hsbc.co.uk/franchise or contact HSBC’s franchise team at firstname.lastname@example.org