What you need to know when financing a franchise purchase
Purchasing a franchise can be a lucrative option for entrepreneurs.
Buying into a thriving restaurant or automotive repair chain, for example, offers you instant brand recognition and can deliver an immediate revenue stream thanks to the chain’s client base and accompanying sales and marketing support. That means less time struggling to turn your start up into a going concern.
But buying a franchise can also be a risky endeavour that can deliver lacklustre financial returns—and in the worst case scenario, outright failure.
One of the essential success factors in your franchise purchase is ensuring you get the right business loan. Investing in a franchise requires a strategic approach similar to starting any business, including willingness to assess different options for financing your purchase.
Understand the risk
The challenge is that franchisees often become highly focused on their dream of running a business. They fail to ensure they have a prudent financial structure in place and the management skills to operate the franchise, says Muhammad Saqib, Manager at BDC’s Enterpreneurship Centre in Mississauga, Ontario.
Turn your franchise into a success story
Saqib, who regularly coaches entrepreneurs on financing and managing their franchises, offers these five essential tips for making your franchise purchase a success.
1. Understand the total cost of your purchase
The price of a franchise doesn’t include the working capital you’ll need to get it up and running. The result, for many entrepreneurs, is a cash crunch in the first few months of owning the business.
“Not incorporating enough working capital into your project costs is one of the reasons many franchises fail,” Saqib says.
It’s a good idea to borrow enough working capital as part of the business loan you get to buy the franchise, he says. He also advises entrepreneurs to look beyond the interest rate on your loan to other factors that will help protect your working capital.
For example, Saqib asks: Can you postpone principal payment to give you time to get your franchise operating smoothly?
2. Shop around for your loan
It’s a good idea to talk to a number of different institutions about your financing needs. You may be able to not only benefit from more favourable terms, but also diversify your sources of financing to reduce risk.
3. Understand the terms of your contract
Franchise purchase agreements can vary greatly from franchisor to franchisor. Knowing who owns the lease on your franchise location, as well as both repayment and ongoing royalty or revenue sharing obligations, is crucial.
“As a franchisee, you need to understand the lease terms and conditions and the contract you’re signing with the franchisor,” Saqib cautions. “In some cases they can pull the franchise license if you don’t hit specific sales benchmarks, or if you fail to meet certain requirements.”
4. Assess your capacity to invest in the business
It’s one thing to save a down payment and have some cash left over for operating costs. But it’s also important to have money available to inject into the business if sales fall short of projections—as is often the case—at least at the beginning.
“You need money set aside either through your own equity position or the banks,” Saqib says. “Availability of sufficient funds is key.”
5. Get your paperwork in order
Financial institutions typically require a draft of the franchise agreement, the franchisee’s statement of personal finances (including net worth) and a business plan.
Once your business loan is approved, Saqib says entrepreneurs shouldn’t be afraid to seek help in running their franchise.
“It’s often a good idea to seek the help of a consultant to coach you through the initial months and years of operating your franchise.”