Most franchisors require that their franchisee candidates have a certain level of net worth and liquidity as part of their qualification process. This requirement is in place as bank funding is typically needed to secure some of the money needed to get the business up and running. For example, if opening a retail franchise, a franchisee candidate will need to budget for:
- Franchise Fee
- Opening Cost: Training Course, Operational Manuals, Site Selection, Start-Up Materials, Legal and Management Fees, Build-Out Supervision, etc.
- Initial Marketing Costs
- Store Development Costs: Signage, Equipment, Computers, Fixtures, Displays, etc.
- Other Expenditures: Rent, Security Deposits, Insurance, Licenses, Permits, Staff Advertising, Travel, Accommodations, etc.
- Working Capital: 3 to 6 months
Once you start putting together the budget figures, most franchisee candidates begin to realise that setting up a retail franchise takes more than entrepreneurial verve; it requires a substantial amount of start-up capital to begin with. In fact, according to the 2008 NatWest BFA Franchise Survey, the total start-up cost for a store retail franchise is typically around £160K. The average start-up fee across all franchise operations is £64,900.
Banks and Franchising
Given the figures above, it is not surprising that most franchisee candidates borrow some money to get their business up and running. In fact, according to results from the 2008 NatWest BFA survey, 81% turn to high street banks to secure some of the start-up cost. And whereas a start-up business might meet with a lot of resistance, banks are extremely supportive of franchising. In fact, many have specialist departments that focus on lending money to both franchisors and franchisees. The dominant players in the UK with market share percentages include: NatWest/RBS (40%), HSBC (16%), Barclays (16%) and Lloyd TSB (15%).
Banks are more favourable to franchising because they are businesses with a proven, tried and tested system which means that the investment risks are a lot lower than a start-up business. In addition, whereas start-up businesses have a very high failure rate with as many as 1 in 2 failing in their first two years — the failure rates for a franchise businesses is quite low — typically 1-5% per annum. Thus, banks are more likely to not only get their money back, but also profit from their investment.
Based on these factors, banks are willing to lend up to 70% of the total start-up cost (including any working capital) for an established franchise system. For newer franchise systems, the figure will most likely be around 50%. And in this current economic environment, security against an asset — most likely a property — will be required to guarantee the loan. If the franchisee candidate does not own a property, a loan application can still be processed via high street banks through the Small Firms Loan Guarantee (SFLG) program. This is a joint venture between the Department for Business, Enterprise and Regulatory Reform (BERR) and a number of participating lenders including the four banks listed above.
The main features and criteria of the scheme are:
- a guarantee to the lender covering 75 per cent of the loan amount, for which the borrower pays a 2 per cent premium on the outstanding balance of the loan, payable to BERR
- the ability to guarantee loans of up to £250,000 and with terms of up to ten years
- availability to qualifying UK businesses with an annual turnover of up to £5.6million
- availability to businesses in most sectors and for most business purposes, although there are some restrictions
Irrespective of whether or not the loan is guaranteed via personal property or the SFLG, all franchisee candidates will need to have a good credit history and also be willing to invest, at a minimum up to 30% of the start-up costs and working capital. These funds could come from personal savings, supportive family/friends, redundancy payouts, etc.
As part of the approval process, the bank will most likely request a business plan. Most franchisors will provide a template, but this will need to be tailored to the franchisee candidate; it should speak to their individual skills and aspirations for the future. Thus the bank will expect to see information on:
- Your career/professional background, assets and liabilities, etc.
- The franchise: what it is and how it works
- Information on the marketplace/sector
- The business location and details of competitors in the area
- The marketing plan to attract and maintain customers
- A detailed breakdown of the start-up costs
- Financial projections, a cash flow forecast and an operating budget
If a franchisee candidate decides to submit their loan application via a bank that they currently do not do business with, in addition to their loan application and business plan, they may also need to provide copies of their banking statements for the last 6-12 months.
Throughout the whole process, it will be important to be realistic in regards to financing needs. Thus, check in with one of the banks at an early stage to have a preliminary conversation about your potential lending requirements. In addition, make sure that the numbers stack up by not only speaking with the franchisor but also actual franchisees who are currently involved with the business. As while franchisee candidates should not overstretch themselves, they should make sure that they are asking the bank to loan them enough money to properly get the business up and running.