Ask the Expert
Author: Rick Chittley-Young, Partner
Date: March 2010
Publication: FranchiseCanada
Q: “When I asked my bank for a loan to help me open a franchise, the lender turned me down; what should I do to get the money I need?”
A: It sounds like you may need to strengthen your “lendability.” Bankers weigh two principal factors when deciding whether or not to extend credit and the amount to provide. They consider how you intend to repay the loan and they consider how to secure the loan in the event you can’t repay.
There are a number of steps you can take to provide a lender with sufficient reassurance to give you the loan you require.
Establish a sound personal credit record
All lenders will check your personal credit profile to assess your credit track record. Thus you should ensure that you have no outstanding personal credit issues or problems. To verify your credit history, request your credit scores and reports from Canada’s major reporting agencies, Equifax Canada (www.equifax.ca) and TransUnion Canada (www.transunion.ca).
If you identify any issues that may be lowering your credit rating such as high outstanding credit card balances or late auto lease payments, resolve these before applying for a business loan.
Prepare a complete personal net worth statement
Since the economic turmoil of the past couple of years, personal guarantees have become a standard requirement for most bank loans. A banker will therefore ask you for a personal net worth or personal financial statement. This document summarizes an individual’s principal assets, liabilities, net worth, sources of income and other financial information that impacts creditworthiness. Providing a complete and accurate statement can improve your chances of securing the funds you need.
Assemble sufficient unencumbered cash to invest in the business
A personal investment of 30-50% (depending upon the type of franchise) of the value of the business loan required in “unencumbered cash” is another standard lending requirement today. From a lender’s perspective, this affirms your commitment to the business and also reduces strain on cash flow during the critical start-up phase of the franchise.
“Unencumbered” refers to capital that is neither borrowed nor used to secure a loan. Securing sufficient unencumbered cash generally involves an investment of your own funds and, sometimes, that of family members, friends or business colleagues.
Develop a clear, comprehensive business plan
Most lenders will expect their investment to be paid back within five to seven years, therefore you need to be prepared to provide a business plan that includes budgeted financial projections demonstrating your ability to successfully operate your franchise and repay the loan.
This plan must include a realistic budget that validates your ability to manage income, expenses and cash flow. A budget comprises cash flow projections and profit and loss forecasts. You’ll need both short-term (monthly statements for 12 months) and long-term (three to five years on a quarterly basis) budgets to show lenders when they can expect a return on their investment in your franchise.
Secure a comfort letter from the franchisor
A “comfort letter” from the franchisor can also provide reassurance to a lender. These formal letters provide some protection to a lender in the event a franchisor terminates an agreement with a franchisee. Some letters may specify, for example, that the franchisor will obtain the lender’s consent if any amendments are made to the franchise agreement. Others may indicate that the franchisor will not terminate a franchise agreement if the franchisee borrower defaults on the loan, without giving the lender an opportunity to remedy the situation.
Match loan terms with your lease and franchise agreement
Harmonizing loan terms with the terms in your franchise agreement and any lease or sublease of premises for your franchise can also help to secure the appropriate amount of capital. If you have a five-year renewal term in your franchise agreement, for example, the terms of the loan you request should not exceed those of the agreement. The same rule applies to leases or subleases; all of these agreements must be compatible.
Finally, rather than risk being turned down – again – for the loan you need, consider seeking objective advice from a professional. Consulting with an advisor who is experienced with franchises can help to quickly pinpoint specific financing challenges and devise appropriate remedies.
Ultimately, it all comes down to being as “lendable” as possible so that you can become the franchise owner you want to be.
Rick Chittley-Young is a principal of BDO Canada LLP, one of Canada’s largest accounting services firms, which helps entrepreneurs, family businesses, franchisors and franchisees succeed. You can reach Rick in the Burlington office (www.bdo.ca) at (905) 844-3206 or rchittley@bdo.ca.
