Can I get a Business Loan to Buy a Franchise?

Get a Business Loan to buy a Franchise, Steve Whiteside, BlueRock Finance

Franchised businesses often have a greater rate of success than independent start-ups. High brand awareness and reputation, efficiencies in marketing, training and product development, established systems and processes…the proven formula towards profit should mean franchise finance is much easier to secure.

However, the uncertainties over the last couple of years, particularly around retail, health and fitness businesses, have meant that lenders are more cautious than ever when it comes to assessing applications for business funding.

But this doesn’t mean you can’t get a business loan to buy a franchise. We wanted to share some insights with franchisors from our experience as finance brokers, so that you’re well prepared with a good understanding of what it takes to get a business loan organised to buy a franchise.

What does Buying a Franchise Mean?

Buying a franchise business involves forming a business entity to essentially pay for a license to sell a company’s (franchisor’s) products and services. That is, one company that is known as the franchisor is selling the rights to use its business name, brand and products to another entity known as the franchisee.

When you buy a franchise, you’re buying the ability to trade under that brand according to their business model and also possibly buying physical assets like the fit-out of a trading premises, equipment, or fixtures and fittings.

Am I Ready to Buy a Franchise?

Before even looking into getting a loan to buy a franchise, ask yourself “Am I passionate about this industry and brand enough to put my or my family’s assets up as security for a loan?”

Does the franchisor have strong training provided that will help enhance your current business acumen and ensure you are successful? What support will the franchisor provide you if something goes wrong? Are there any requirements to upgrade the business or fit-out the business every few years and do you have the resources for this if it’s a real cost?

These are only a few of the questions you need to ask yourself before you commit to finding a loan to buy franchise.

Get Vital Franchise Documents Before You Approach the Banks

Step one to ensuring you have the best chance at a business loan is to get all the necessary information and disclosures from the franchisor. If you are not satisfied with what you’ve been provided, keep pushing until you get the information that makes you comfortable.

Franchisors are obliged to provide sales averages and data to prospective franchisees to help them make an informed decision around a possible purchase. Likewise, the franchisor will want to know enough about you as a prospective franchisee to ensure they aren’t building a partnership with someone who isn’t credit-worthy or is unreliable or not driven and passionate about their brand.

The franchisor should be able to provide you the key documents, being the Draft Franchise Agreement and their Franchise Disclosure Document, which will detail the royalties and marketing to be paid to the franchisor, the cost of the purchase and any franchise fees, plus other important information such as the contact details of existing franchisees across the country (which you should contact first-hand to ensure the sentiment towards the brand is positive).

Understand the Real Cost of Buying a Franchise

When approaching the bank for finance, it is important to know exactly what the all-up costs of a franchise are. The number of clients I’ve spoken to who seem uncertain around what the true cost of a franchise is continues to alarm me.

The costs to buy a franchise can be extensive and are often ‘moving targets’ if the franchisor is still working on a location for the franchise, the magnitude of the fit-out, and securing a lease agreement if premises are involved.

Many potential franchisees also don’t consider bank guarantees (normally 3 months of rent held in a term deposit or against property if there are commercial premises being rented) or starting a cash float to make it through the first 2 or 3 months of trade no matter what sales do.

It’s also important to know if the franchise price includes GST or not and whether there will be any incentives paid by the landlord for the new store’s fit-out.

The Disclosure Document should clearly outline all the necessary costs but before calling a broker or talking to a bank, make sure you are 100% across all of it, including the franchise fees, the royalties and the marketing costs. Plus think about peripheral costs like solicitor fees to review all the franchisor’s documents, accountant fees to help you run your own cash flow for the business inclusive of GST, super and payroll taxes etc.

You also should ensure you have at least 3 months’ worth of operating expenses in cash available to you to keep the business trading if the opening isn’t as strong as planned.

Considerations for a Franchise Business Loan Application

Once getting your head around the all-up cost and business model through the mandatory franchisor disclosures, you should be able to understand what sort of loan you require to purchase the franchise, based on your current cash savings (or offset funds).

For example, if the franchise will cost $650,000+GST all up, inclusive of franchise fees, bank guarantee, legal expenses, starting cash float etc. and you have only $100,000 in cash, then you will obviously be needing a bank to lend you $550,000 plus potentially another $65,000 in GST (which you should hopefully get back in time, dependent on business trade).

Getting in touch with a finance broker who has experience and relationships in dealing with the various lenders and their requirements can be valuable in understanding what would be required to secure a business loan to help fund your purchase.

The below points are essential when it comes to a banker making a decision to lend. As a broker I ensure these are covered off in detail before sending the feelers out for business finance:

  • Business experience – Do you have any experience in the same industry (ideally 3+ years in the same industry)
  • Level of business acumen – e.g., prior experience running a small business. Do you know what GST is? Have you managed people or dealt with stock before? Do you have sound accounting knowledge and the ability to budget and analyse the financial health of a business?
  • Reason to Buy – Banks want to know what the drive is for a franchisee to buy a franchise. Are they passionate about the industry or do they just want to own a stable business and believe in the brand?
  • External Income – Are there any income sources outside the new franchise? Are you a multi-site operator? Will other family members continue to work to support living costs and other loan requirements outside the new business? Utopia for the banks, especially if it’s a brand-new franchise, is that your external income services the new business loan without any profit from the new business itself.
  • Collateral – The bank will want to know what their ‘safety net’ is if the worst occurs and the business fails. Relying on a franchisor to ‘buy back the business’ is not sufficient and though the business and the lease should be worth something, the bank is looking for ‘skin in the game’ primarily and this means the pledging of personal assets. Often, however, it should be possible to avoid property as security if sufficient cash is available to put towards the purchase price. However, saying this, the banks would still want to know that the prospective borrowers have a sound and understandable asset position (i.e. if both borrowers have worked solidly for 10 years but have no real savings or assets, why is this the case?).
  • Capital – How much of the total cost of the franchise is being put in by the franchisee (the more the better)? What is the incentive and what is real equity from the borrower? Is there any spare cash (liquidity) available if required in a worst-case scenario?
  • Compelling Business Plan and Cash Flow Forecast – Time to showcase your business acumen. Who will be running the franchise and what are their backgrounds and experience? What staff will be required? What does the first 12 months look like from a sale/profit perspective and what are the underlying assumptions to the cashflow? Also, it’s best to include a SWOT Analysis and as much information as possible to show the bank you know what you’re talking about and that their money is in safe hands!
  • Credit Checks and ATO History – So there are zero surprises with the eventual application, make sure to run a credit check on yourself and any companies you are a director of to ensure there are no issues. Separately, if you already run a business, make sure you have all your ATO requirements in order, if they aren’t and you can’t confidently show the bank a clean 12 months running balance of your ITA or ICA, you may find it hard to secure funding no matter what the excuse is. Even if the excuse is logical or reasonable to you, the banks typically have a scorecard for new lending and if there are any ATO arrears you could find it impossible to get them comfortable. Banks see ATO arrears a potential character concern and though accountants regularly advise to ‘lean on’ the ATO, my experience is the banks never love it.
  • Information About the Franchisor – The more the bank knows about the franchisor’s health and existing franchisee network, the more likely they should be able to lend to you (if it’s positive).
  • Is it a new franchise (‘Greenfields’) or an existing franchise you’re buying? Banks will feel much more comfortable lending for an existing business that has financials available, rather than a brand-new business based on a cash flow forecast and business model.

How Best to Apply for a Franchise Business Loan?

Finding an experienced finance broker who knows what a franchise model is and is connected to small business bankers, and also the franchise divisions of each bank, is the best possible starting place for applying for the loan.

A good finance broker will give you a ‘Quick No’ if it’s just not going to stack up, or will coach you around what is lacking and may be able to improve your chances of future finance. They may have options for you in terms of clearing ATO arrears and freeing up cash before the application to ensure you have the best possible incoming scorecard for the banks.

The more experienced the broker, the more tales of woe they will have to share with you around ‘how not to apply’ and what to really watch out for.

What is the Best Franchise Loan Structure?

Your experienced finance broker or banker will be able to work with you around the expected loan structure for the new franchise so you can work it into your cash flow forecast. Typically, the banks will lend a shorter term for anything unsecured or against the balance sheet itself (5 to 7 years, often in line with the lease/franchise agreement), and they’ll lend on property-backed loans for terms of 10 to 30 years (or interest-only) meaning the cash flow stress can be much lower if you decide to pledge property.

For a limited time, there is still the opportunity to also incorporate the government’s SME Recovery Loan Scheme into your lending structure. The scheme provides very competitive terms and rates on unsecured (or commercial secured funding) but will only be possible if you already run a business, which was negatively affected during the COVID-19 pandemic.

Brand-Based Lending Rules for Franchises

Banks often have specific policies around lending to the more household names in franchising and this varies from lender to lender. They often have an undisclosed list of ‘preferred franchises’ and they could lend anywhere from 30% to 70% of a new franchise business based on the brand itself (subject to all the other criteria above being met of course!).

If you would still like some advice on the best ways to secure franchise finance, our multidisciplinary franchise team is well-placed to deliver cost-effective, time-efficient and innovative advice on every aspect of your franchise system. 

Feel free to reach out to a BlueRock franchise specialist.

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