Ask A Financial Expert
FranchiseCanada Magazine,
March/April 2003
Q: What are the best sources of franchise financing and how do I go about securing the capital I need to get the franchise up-and-running?
A: There are four principal sources of financing upon which most franchisees rely to get a new franchise started or to expand an existing franchise.
1. Yourself
You should be the first source of financing for your business. The number one cause of business failure in North America is over-leveraging: too much outside debt and too little owner equity in the business. Without a solid capital base that is self-financed, companies tend to have high equipment and operating loans that are expensive to maintain. Moreover, few investors or lenders will line up to provide capital unless the owner personally assumes some of the risk. A good rule of thumb is 25 percent of the total debt.
2. The Banks
Bank financing is typically the second source of funding for franchises. The banks principally extend short-term financing for working capital and operations. Banks will generally fund 70 to 75 percent of receivables less than 60 days old as well as a percentage per dollar of equipment, ranging from 50 percent to 65 percent depending on the type of equipment and the type of business.
Your banker will expect personal guarantees up to the maximum amount of the loan. He or she will also want to see an initial shareholders’ cash deposit of at least 25 percent in unencumbered cash for working capital.
Lenders also expect to see a thoughtfully crafted business plan outlining the potential of your business. You need to develop a plan that will convince lenders and any other investors that an investment in your franchise is a wise financial move. Your business plan should portray your vision, clarify your goals and answer the questions investors and lenders will ask. Here are the basic elements.
- Begin with a summary describing the franchise you intend to purchase and how you intend to make it a success. Include the background and track record of the franchisor and its franchisees, products/services and your market.
- For many lenders, the management team is the single most important factor in the success of a business. Describe your skills and experience and explain why you are suited to manage this franchise. If there are other people who will be part of your management team, do the same for them.
- Describe the features and benefits of your products or services. Explain how they differ from those of the competition. Also, outline how you will deliver your products/services to your customers.
- The marketing section should describe your market sector, the competition and future prospects for your business. Itemize your strengths and how you will leverage them, your weaknesses and how your will strengthen them, threats to your business and how you will handle them, and opportunities and how you will optimize them. Estimate the market share you plan to achieve, describe your customer-base and outline your marketing plans.
- Describe the features and benefits of your products or services, how they differ from those of the competition, and how they will contribute to achieving sales and revenue targets.
- In the operations section, describe the business premises and explain how you intend to produce your products/services, referring to location, property, facilities, leases, employees, insurance, technology, equipment and suppliers.
- In the financial section, you need to address the financial potential of the business and describe your own financial situation. Include monthly budget and cash flow projections for the first two years of business. Also include personal financial statements that provide a picture of your net worth.
Review your business plan from a lender’s perspective to ensure the document will assure investors that:
- There is a market for your products/services,
- You and your management team are capable,
- You have the necessary physical and financial resources,
- You have identified challenges and established plans to meet them, and
- You have thought through your plans, timelines and contingencies.
3. Business Development Bank of Canada (BDC)
The BDC is most often the next source of capital for franchisees. The BDC charges interest rates slightly higher than those extended by the banks. While the BDC extends loans for similar purposes, as do the banks, most franchisees look to the institution for loans on land and buildings, which bankers are more reluctant to finance. The BDC typically holds the first mortgage and lends up to 65 percent of the fair market value of either asset. In return, you will pay interest rates slightly above bank rates.
4. Family and friends
Many franchisees find their family and/or friends want to participate in their new venture. Thus, they often become the fourth source of franchisee financing.
In most cases, such arrangements are structured as non-interest bearing, non-arm’s length loans with favourable terms of repayment. A lawyer can help you secure loans behind the banks and secured creditors, but above trade payables.
With interest rates currently at historic lows, this is an ideal time to secure the capital you need to start your franchise for the longest possible terms and the lowest possible rates.
Rick Chittley-Young, B Comm, CGA, is a principal of BDO Dunwoody LLP (www.bdo.ca), one of Canada’s leading accounting firms, which helps entrepreneurs succeed. Rick, who is located in the Oakville office, helps franchisees and franchisors launch and expand their businesses. If you have questions about this article or would like to receive BDO’s “Tax Factor” newsletter, contact Rick at tel: 905-884-3206, fax: 905-844-7513, e-mail: rchittley@bdo.ca, or 151 Randall Street, Oakville L6J 1P5.
