Franchise Finance

The line people underestimate is the last of the two: the buffer. A new site rarely trades at system average from week one, and a lender who sees no buffer in the plan will assume you have not costed the ramp-up properly.

This is the single most important structural point on this page. A franchise agreement has a term. When it ends, your right to operate ends unless it is renewed, and renewal is generally at the franchisor’s discretion on the terms then offered.

1. 01A lender will normally want the loan to amortise fully inside the remaining term of the franchise agreement, including any options only where the lender is satisfied they are secure.
2. 02A short remaining term therefore compresses the loan term and raises the repayment, even where the business is performing.
3. 03Buying an existing site with three years left on the agreement is a very different funding proposition to buying one with a fresh ten-year term.
4. 04The same logic applies to the property lease. A fit-out amortising past the end of the lease is a structural error, because the asset stops existing for you when the lease ends.
5. 05At renewal, franchisors often require a refurbishment. That cost is foreseeable and should be planned and funded, not met as a surprise.

Disclosure document

The document the Franchising Code requires a franchisor to give you before you sign, setting out the system, the costs and the obligations. It is written to be read closely, with a solicitor.

Agreement term

How long your right to operate runs for. The loan will generally have to amortise inside it, so a short remaining term compresses the loan and raises the repayment.

Renewal

The point at which the franchisor decides whether to grant a further term, generally on the terms then on offer. It is a discretion, not an entitlement.

Refurbishment obligation

The requirement to bring a site back to current specification, commonly triggered at renewal. Foreseeable from the day you sign, and best funded on a plan.

A large part of what you are buying is the right to trade under a system. That right is valuable, and it is very hard for a lender to realise if things go wrong, because the franchisor controls who may hold it.

• Expect a General Security Agreement over the business assets and personal guarantees from the directors.
• Goodwill on its own is rarely accepted as standalone security. Lenders lend against it, but they want something else behind it.
• Property security, whether yours or a family guarantor’s, is what usually secures the longer term and better pricing.
• Equipment can be financed separately against the assets themselves, which preserves the main facility for the fee and the fit-out.
• Franchisors sometimes hold step-in rights that affect what a lender can do on default. Lenders accredited to a system will already understand these; other lenders will want to read them.

1. 01

   Get the disclosure document and the agreement early

   Along with the franchisor’s indicative set-up costs and any performance information they are willing to provide about comparable sites.

2. 02

   Check accreditation

   Which lenders already know this system. That determines both the likely terms and how long the process will take.

3. 03

   Build the funding table

   Every cost, what is funded and by whom, what you contribute, and the working capital buffer. Lenders want to see total cost, not just the loan request.

4. 04

   Model the ramp-up honestly

   Revenue building over months, not weeks. Wages, rent and franchise fees from day one. If the model only works at system average, it is not a model.

5. 05

   Structure around the agreement term

   Loan term inside the remaining franchise term, fit-out inside the lease, equipment inside asset life. Three different pieces, three appropriate terms.

6. 06

   Settle, then set the calendar

   Renewal dates, refurbishment obligations, lease options and review dates. These are foreseeable costs, and franchisees who plan for them do not get caught by them.

Taking over a trading franchise is usually easier to fund than a greenfield site, because there are real numbers rather than projections. There are also more questions to ask.

• Why is the vendor selling. The answer is sometimes in the numbers and sometimes in the lease.
• How many years remain on the franchise agreement and on the lease, and what renewal will require.
• Is a refurbishment due, and who is paying for it.
• What condition is the equipment in, and what will need replacing in the first two years.
• Are there arrears with the franchisor, the landlord or the ATO attached to the business, and how are they being dealt with at settlement.
• How much of the trading performance depends on the current owner working in the business full time.

Your accountant should review the financials and the vendor’s tax position before you sign. A lender will ask the same questions, and it is much better to have the answers ready than to discover them during due diligence.