Setting up costs
The cost of taking up a franchise will vary according to the nature of the business and the size and location of your premises. You could invest as little as £5,000, or as much as £500,000. You will have to pay some or all of the following fees and costs:
- Initial franchise fee – this is a one-off fee to ‘buy-in’ to the business. It reimburses part of the franchisor’s costs in developing the franchise operation, recruiting you and, where appropriate, helping you find suitable premises. The fee is normally 5 –10% of the total investment cost, although the percentage may be higher for a low cost franchise. The fee should not include a large profit element for the franchisor.
- Training fees – usually included in the franchise fee, but sometimes itemised as a separate charge.
- Premises – occasionally, the franchisor may take the head lease and grant you a sub-lease. There will sometimes be a premium and/or advance rent to pay.
- Shopfitting – the franchisor may have arranged for a specific firm to fit premises out in a standard format. ¢ Vehicles – you may choose to purchase outright, but are more likely to take out a lease or hire purchase agreement. If so, the setting up costs will include an initial deposit only.
- Initial stock – may be purchased from the franchisor, or from an approved supplier. You should have help from the franchisor in establishing how much initial stock is required.
- Equipment – may be purchased from the franchisor, although you may be able to hire or lease it.
- Working capital – to cover the initial salaries, and other business expenses, until cash is generated.
- Promotional costs – the cost of local advertising, mail shots, etc. These may be covered by the franchisor and included in the franchise fee.
Ask yourself the following questions:
- What is the total cost of the franchise and what contribution can you make from your own resources? Prepare a full list of your personal expenditure, this will show you how much money you will need to take out of the business in order to live.
- Will you need to borrow and, if so, how much?
- Do you need an overdraft to assist with working capital, or a loan for the purchase of fixed assets – or both?
- What security can you give to back up your borrowing?
- How long do you need to repay the loan? Remember that any loan will need to be repaid by the end of the franchise term.
Now that you have your two most important forms of documentation ready – your business plan and your credit history report – it’s time to research funding options. Generally, it’s seen as best practice to have enough personal savings to provide a third (or 30-40%) of the total start-up costs yourself. If, however, your chosen franchise is a newly established business, it is likely that you’ll be expected to provide closer to 50% of the initial costs, due to there being less historical evidence of how the business will succeed.
A common way to get the remainder of the funds needed for your franchise is through a loan from the bank. Although bank loans are a very popular option, do remember that the more money you borrow to set up the franchise, the higher your repayments will be and therefore the larger proportion of your own profits will go towards paying back the bank for the foreseeable future.
Choosing a bank
Major high street banks tend to have specialised franchise departments, which are accredited by the British Franchise Association. These include:
- Royal Bank of Scotland
- Lloyds TSB
It pays to shop around for the best interest rate and loans for your situation; don’t just settle for the first bank you speak with, or go to your usual bank just because they are familiar to you. This is a major decision so it’s crucial to take the time to evaluate your options. If you’re attending a franchise expo, there’s also the option to speak to the representatives of different banks who will have stands there, so you can compare what they have to offer.
Speaking to your franchisor about finance
Banks are generally receptive to funding franchises, simply because they are seen as a safer route than setting up your own business from scratch. Other franchises operating under the brand will demonstrate to a bank that the business model is sound and its potential to drive revenue is satisfactory.
A number of the major franchisors will have built relationships with particular banks already, which can often assist a franchisee when the time comes to apply for finance. Speak with your franchisor as part of your financial research to find out if they might be able to obtain a more favourable rate for you with their chosen banking institution. For an example of how franchisors might provide finance look at our case study from Auditel.
Should you get advice before seeking finance?
It’s a good idea to seek the help of an accountant when it comes to your finances. Although banks are very helpful, they too are trying to make a profit and it’s important to get advice from an external source to be sure you are getting the best arrangement possible for your situation.
The National Association of Commercial Financial Brokers is a also good place to start, and you can find a credible broker through their website. You could also enlist the help of a legal professional who is experienced in the field and registered with the Law Society.
Finance options for franchisees
Here are some of the different types of finance you should be familiar with before approaching a bank:
Both fixed rate and variable rate loans offer you the chance to borrow the capital needed for your venture and pay it off over a set period of time. With a fixed rate loan, you pay back what you borrow over a set period of time and your repayments stay the same over the entire period, with one fixed interest rate throughout. A variable rate loan on the other hand will come with an interest rate which fluctuates with the rise and fall of market interest rates, meaning that the amount you’ll repay on your loan each month will vary depending on the rate at that time.
Overdrafts are an alternative to a loan and are better suited to short term borrowing. The advantage of an overdraft is that it allows for flexibility when it comes to repayments, however the overdraft facility can be removed at any time by the bank and interest rates mean it is often a more costly option in the long run.
Asset finance and leasing
Usually used for short term borrowing, asset finance is a way to get the working capital required for the initial stages of your business. It involves borrowing against the security of assets such as your accounts receivable or inventory. Banks will have their own leasing companies usually, which can be used for items such as vehicles.
This type of finance involves borrowing on the strength of the invoiced payments owed to you. It means that the loan itself will change in size depending on how much business you are doing and what is being repaid. This is often an expensive route to go down.
What to expect when you meet with the bank
It can be daunting for first time franchisees to meet with the bank, with the prospect of a loan approval pending. For this reason, it’s essential that you’re prepared and you know what to expect in advance. Know your business plan inside out, and be ready to answer any tricky questions about your finances.
Here are some things the bank will be looking for when you apply for a loan:
1 Your franchisor
Banks will want to see demonstrable evidence that the franchisor you’ve chosen is financially secure, and that the franchises operating under the brand are doing so successfully. They will also take into account how well established the franchisor is, and how long they have been in business for.
2 You and your franchise
In addition they will want to see that your business plan is well prepared, and contains realistic figures for expenditure and profits. One thing they might do is look to see if there are similar successful franchises on their books and see if their figures are in line with yours. When it comes to your business plan its best to avoid using a generic template; this is off-putting to banks and shows that you may not have put in as much work as you might have were you to create it entirely by yourself. Lenders will also look at:
- Your skills and experience – for example, if the business requires a knowledge of marketing, how good are you at selling yourself?
- Your financial awareness – how familiar are you with the financial concepts and figures outlined in your business plan?
- Your contingency plan – what alternatives do you have in place if things don’t go as expected?
- What your lender should tell you
- When having a discussion with lenders, there are some items you should have on your checklist. Be sure to note down all of the following:
- A list of all the fees and interest rates that the loan involves
- The covenants that come with the finance. These are the restrictions or conditions under which your loan will be granted to you
- Does the lender allow you to make overpayments on the loan, which would enable you to repay the loan earlier than agreed? Is there a charge for early repayment?
- If you are late with your payment, what are the charges involved?
- Does the lender allow you to take repayment holidays, and if so, under what conditions?
Securing a loan
Generally speaking if you’re borrowing an amount larger than around £25,000 you will need some sort of security for that loan. Security refers to collateral which is used to back up your ability to repay a loan. For example, if you use a property that you own to secure your loan, it means that should you be unable to repay the loan for any reason, the property itself can be used to pay your debts instead.
The Enterprise Finance Guarantee (EFG)
If you don’t have assets such as a property to secure finance with, there are alternatives. Set up in 2009, the Enterprise Finance Guarantee is a scheme run by the Department for Business Innovation & Skills, whereby the government will guarantee up to 75% of your bank loan amount, meaning you don’t need a large amount of security to back up what you’re borrowing. The scheme is applicable to loans with a minimum amount of £1,000 and a maximum of £1,000,000, for loan terms between three months and ten years.
As part of the EFG, you can receive your funds in stages, in the form of an overdraft, invoice finance or lump sum. You can also take repayment holidays, during which time you only pay the interest amount on the loan. A wide range of businesses are eligible for the scheme, although approval for the EFG is subject to normal lending criteria and is at the individual discretion of participating lenders. Or more information you can ask your lender, or look at the Business Link section of the government’s website.
What are some of the reasons a loan application is rejected?
If your loan application isn’t approved, it’s likely that there are very specific reasons, for example:
- You have a poor credit history
- There is something on your credit history report which makes you an unfavourable candidate to lend to. See our previous section on credit history and what you can do about this.
- Your business plan is missing information
- There is a gap in the information you’ve provided in your plan. There needs to be enough detail in your business plan to leave lenders in no doubt as to your finances, present and future.
- There isn’t evidence of enough cash flow for you to live on
- If you’ve miscalculated your figures, or if you’ve overlooked adding them up in one particular area, you could be unintentionally giving the bank a reason to reject your application. There must be enough money evident, after all your expenditure, for you and your family to live on from day to day.
- There isn’t evidence of enough cash left to meet your repayments
- If it looks like there won’t be the funds left at the end of each month to make your loan repayments, it’s unlikely that the bank will want to lend to you. Go over your figures again to make sure they marry up.
What are your options?
If there is a barrier to you getting finance from the bank, don’t panic just yet. There are other sources of funding open to you, which we will discuss in the next section.