Approaching the Bank for Franchise Financing
BY MARA ASHRAF
The time to approach your bank to discuss financing your franchise is after you, the potential franchisee, have done your “homework”. The objective is to make a well-informed decision before embarking on a new business venture by conducting due diligence that will help you to understand your rights and obligations as a franchisee, as well as those of the franchisor. The due diligence process should include a thorough analysis of the franchise system, including reviews of the franchise agreement and disclosure document, while also seeking legal advice, asking questions of the franchisor and talking to other franchisees.
By developing a clear understanding of the franchise model and process, you should be better prepared to identify the risks and opportunities that need to be addressed and managed as an entrepreneur operating within a franchise framework.
As you make your way through the franchise selection process, you will need to ask yourself whether you and the franchisor are a good fit. You should surround yourself with qualified professionals in legal, accounting, financial, marketing, franchising and other specialized areas who can assist you in evaluating your business opportunity. You should also take advantage of other valuable resources, including industry associations, federal and provincial government websites and your bank.
Consider your bank to be an integral part of your team of specialists, working with you to work toward the success of your new business venture.
What Is Typically Required
Requirements can vary since every transaction is different. Generally speaking, a bank needs to understand the concept being proposed and must have confidence in the franchisee’s ability to successfully operate the franchise. Transparent communication is paramount, and your experience with the bank often depends upon the quality of information, both verbal and written, that you provide.
Once you have determined your financial needs, you will need to prepare a clear, concise and comprehensive package for the bank to review. The package should include financial information and a business plan, as well as details of the franchise system, provided by the franchisor, which should include a copy of the franchise agreement and lease.
A well-prepared franchisee will present the bank with organized documentation to help simplify the process. Approaching a bank that specializes in franchise financing can further facilitate the review of your file.
In some instances, a franchisor may have a financing program in place with one or more banks in order to facilitate the process. Ask your franchisor if that is the case, as it can expedite the process if your bank already knows the particulars of the franchise system. Otherwise, in the absence of a financing program, the bank must familiarize itself with the franchise system while simultaneously reviewing your file.
Remember, the success of a franchise depends largely on a franchisee’s ability to execute the franchisor’s concept. A franchisee can communicate his or her ability to achieve that goal through a detailed business plan presented to the bank and through subsequent discussions pertaining to that business plan.
The Business Plan
While a business plan is an essential tool required by the bank in order to review your request, it also serves as a franchisee’s plan of action. Your business plan is a blueprint of strategies and “what if” scenarios that will help to pave the way to success and safeguard your success in the face of challenges.
There are numerous tools and guidelines available for developing business plans for prospective franchisees, including government websites, bank websites and through consultations with accountants. The following provides an overview of some of the information requirements for a franchisee business plan, which should:
Demonstrate the franchisee’s ability to carry the business venture through to fruition, instilling confidence in the franchisee’s expertise in the operational and managerial aspects of the business. Remember, while a franchisee does not need to be a finance specialist, they do need to exhibit the ability to run their business well;
Illustrate the business’s keys to success, highlighting the potential risks and mitigating factors;
Clearly present the franchise concept, including industry and market data provided by the franchisor, details on the level of franchisor involvement and expectations of the franchisor’s support for franchisee operations;
Outline how potential problems and roadblocks would be addressed in order to ensure the continuity of operations.
In essence, a business plan should demonstrate a franchisee’s preparedness and ability to plan for contingencies, based on unforeseen challenges that may impact the business. This approach also helps the franchisee to look ahead and to plan for the continued success of the business.
Including the “numbers” aspect in any business plan is important because numbers essentially tell a story. Who is supporting the business? What resources are required for the business to operate? What level of activity is required in order to cover costs? Where does the business earn its money and where does it spend it? What happens to any money that is left over? Financial information that answers those questions will typically include:
Personal financial information about the franchisee: A franchisee’s financial profile should demonstrate good credit history and ample net worth, displaying an ability to inject additional funds into the business, if necessary;
Financial statements of the business: This should include a balance sheet (what the business owns and owes), an income statement (what the business earns and spends in a fiscal year, and what is left over) and a cash flow statement (how much cash is generated by and used in the business’s activities);
Financial requirements: As a starting point in determining your financial needs, you may want to prepare what is commonly referred to as a “sources and uses of funds” table. This two-column table provides written financial requirements on one side (equipment for X dollars, for example), while the other side details how those financial needs will be met. The latter should answer questions such as what sort of combination of equity (the owner’s/franchisee’s investment) and debt (loans) will be used to meet those needs? Are you prepared to meet the financial obligations alone, or do you plan to work with partners, in conjunction with a loan from your bank? The total of both columns should be equal.
Financial projections over time: Considering that a franchisee is responsible for delivering financial projections, it is important that you understand the numbers and agree with what is being presented. Financial projections should be realistic and should demonstrate: (i) sufficient equity invested in the business; (ii) the capacity of the business to produce sufficient cash flow in order to cover its operations and to repay the bank loan (principle and interest).
The percentage to be financed by a bank and the amount of investment required by a franchisee depend on a variety of factors, including:
the requirements and particulars of the franchise system;
the franchisee’s business plan;
the franchisor’s involvement in the franchise system;
the franchisee’s financial profile.
When preparing a business plan, accounting professionals can provide franchisees with assistance on the technical aspects, and franchisors can provide financial information for a typical site. Through the disclosure document and subsequent discussions with the franchisor and other franchisees, a prospective franchisee should have a clear picture of the costs required to open and run their new business. The bottom line is that you need to ask questions in order to understand the financial requirements of the business venture that you are embarking upon.
In revisiting the basics of how to approach the bank for franchise financing, our goal is to convey the importance of being well prepared, which can dramatically increase your chances of success. Remember, while working with you, the bank wants your new business venture to succeed.
Mara Ashraf is Manager, Franchise & Commercial Partnerships at National Bank of Canada and can be reached at email@example.com