Taking up a franchise is becoming an increasingly popular way to start a business. Research has shown that successful franchises have a much lower failure rate than other start up options and, in most cases, the business model being purchased has already been tried and tested.
However, with the average initial cost of starting a franchise currently at £42,200 (including the franchise fee, working capital, equipment and fittings, and stock) one of the key considerations facing those looking to take up a franchise opportunity is how to finance the business, cover these initial costs and begin to trade successfully.
While some will be able to fund the initial purchase from their own resources, many will require financial support. Traditional finance options, such as secured lending from a bank, will often require you to have some start up capital to invest in the business. However, there are alternative finance solutions if this capital isn’t immediately available. In addition, asset finance, working capital finance and trade finance can all be used to your advantage to help you through the initial start up phase.
This article provides an introduction to the start up finance options and discusses why a comprehensive, tailored business plan can be the deciding factor in whether your business is accepted or rejected for funding.
Banking on a loan
When you are looking to finance a franchise, your first port of call will often be your local business bank. The high street banks tend to have specialist franchise units that can advise on services and products tailored specifically for this market, and it can pay to shop around to find a deal that is right for you.
Before approving you for a loan, many banks will expect you to contribute a proportion of the start up capital from your own resources. Typically this will be between 30-50% but will vary depending on the lender and your own circumstances.
In addition, lenders will often require some form of security to protect their investment if you cannot meet repayments and default on the loan. While some lenders will accept a second-charge mortgage on your residential property, others may accept a personal guarantee with or without additional security.
What if the bank says no?
However, if you’ve been turned down for a loan to purchase a franchise because you don’t have sufficient security, you may be eligible to apply for the Small Firms Loan Guarantee scheme.
Launched by the Department for Trade and Industry (DTI) in 1981, the scheme makes available amounts between £5,000 and £250,000 for small businesses that don’t have access to funds or assets that could be used as security against a more traditional business bank loan. The DTI provides 75% of the security for the loan. However, this is no guarantee that the banks will be motivated to support your application.
There is a wide range of qualifying criteria that you will need to be aware of, and the application process can be quite daunting if you plan to tackle it on your own. For example, you will need to be aware that eligibility is restricted to those businesses that have been operating for less than five years, and those with turn over of up to £5.6 million.
While your bank may be able to guide you through the application process, it may pay to gain additional advice and guidance from an independent adviser. They should be able to guide you in preparing your business plan to maximise the chance of your application being successful. However there is certain criteria that your business plan must meet and it is important that your adviser is aware of these.
Working capital finance
Whether you have used your own money, secured a bank loan or raised unsecured finance to pay the franchise fee and invest in premises, equipment and stock, you will need working capital to ensure your franchise can pay its bills and trade successfully.
For those who simply require a temporary cash boost it may be worthwhile arranging a traditional overdraft facility with your bank. This provides additional funding in the short-term so you can ensure your bills are paid on time. However, you will accrue interest charges when you use this facility.
Another option open to you is invoice financing, which can be used when your creditors don’t reimburse you promptly when you send them an invoice. For a percentage of the invoice amount, a financier will provide you with up to 90% of the total of the invoice, subject to certain qualifying criteria, before it has been paid by your creditor. This can free up additional working capital which can then be used to keep the business in operation during the period when you would normally be waiting for the invoice to be paid. The real advantage of this form of working capital finance is that it grows as your business grows
If you need to invest in expensive equipment, asset finance may also be a worthwhile option. Operating in a similar way to a hire purchase agreement for consumer goods, asset finance enables you to pay a regular ‘hire’ or ‘rental’ fee for the equipment you require. There are a variety of asset financing options that can be tailored to suit your business.
Putting the plans in place
Before applying for any form of finance you will need to draw up a comprehensive business plan. This is one of the most important documents you will write for your business as the information contained within it can be the deciding factor between whether a lender accepts or rejects your application for finance.
Your business plan should provide a clear and realistic overview of the market for your product or service along with details of your business strategy. The key section that lenders will be interested in is the financial plan, which will need to contain thorough financial forecasts for the next three years. It will also be necessary to include information from your franchisor on the business metrics they have worked out for your area.
Banks, financiers and other commercial lenders will use your business plan – particularly the financial forecasts – to reassure themselves that you can meet any required repayments on loans. This is why it is important to make sure the business plan clearly sets out your intentions and provides a realistic overview of what you can expect to achieve in the first few years of trading.
However, when applying for certain types of finance, such as the Small Firms Loan Guarantee scheme, you will need to ensure that the structure of your business plan meets the specific requirements of the scheme.
Where to go from here
There are a number of different ways in which you can raise finance to purchase a business franchise. Your franchisor or an independent adviser should be able to provide advice and guidance on the options open to you. However, remember that the finance market is increasingly competitive, and it may pay to shop around to find the bank or commercial lender that offer the best rates and terms for your franchise business purchase.