A Franchisee’s Roadmap To Obtaining Financing
FranchisingAuthor :
Martin Greenspon 
Martin Greenspon founded M-Four in 1981. His lifetime career has included the manufacturing sector as well as being a Director of one of Canada's leading investment firms. He can be reached at martin@mfourintl.com
With franchise investments running anywhere from $150,000 to $200,000 on average in Canada, many entrepreneurs must seek outside financing if their focus is on entering the franchise forum and have the opportunity of becoming self-employed.
Canadian Franchises sell more than $100 billion worth of products and services every year making Canada the second largest franchise market in the world after the U.S.
There are over 1000 franchise systems operating in Canada, representing almost 76,000 franchise system outlets, employing a record 1.5 million Canadians.
Given that financial institutions and various levels of government recognize the value of backing such projects, there are now a variety of ways to fund a proven franchise model.
For many bankers, anyone who has made it through the franchisor’s screening process and credit check is worth taking a look at as a potential customer.
At present, one of the most popular ways to finance involves the federal governments Canadian Small Business Finance Act (CSBF). Under this program, the federal government in effect co-signs a loan with the franchisee for up to 100% of the financing needed, up to a maximum of $350,000. This benefits both financial institutions and borrowers. With the federal guarantee, the bank’s exposure is lessened, while the franchisee pays lower rates under such an arrangement, typically prime plus 3% for the term of the loan, which on average is five to seven years.
These loans are more liberal than traditional financing because they will usually cover not only fixed assets but also leaseholds, which have no residual value and can’t be resold. Formerly, security was required to finance such items.
What this sort of loan will not cover is working capital, the money needed to cover expenses such as payroll and inventory. Federal funding is also available through the Business Development Bank of Canada (BDC).
While the BDC is referred to as the ‘Bank of last resort’, it sometimes funds projects not accepted by the banks because the commercial banks must think of their shareholders, whereas the BDC’s mandate is to break even. It is also willing to look at longer terms than the big banks. BDC will finance up to $150,000 where the franchisees rate is approximately 4.25% - 8%, depending on the risk.
While government’s willingness to back loans is appealing, there is no getting around the amount of equity a franchisee is expected to put up when arranging financing.
Banks and franchisors expect anywhere from 30% to 50% must come from the entrepreneur’s net worth.
The CSBF and the BDC are there to help but they still want to see that you have some hard assets yourself. With fees, hard assets, working capital, ongoing royalty fees and central advertising costs, any less and the debt would be too heavy.
Once the fixed costs are covered, franchisees must also arrange some sort of fluctuating line of credit to cover their operating costs. One of the reasons a potential franchisee should have good cash flow projections mapped out, with the franchisor’s input, to explain how the franchisee intends to cover the ongoing costs, such as salaries and inventory, that are needed to keep a business working, given it will probably take at least six months to break even.
In many cases, banks also require a ‘Letter of Comfort’ from the franchisor, stating that the franchisor will buy back equipment and undertake to remarket the franchise unit should the franchise run into difficulty.
There are other options to financial institutions which are available to franchisees such as leasing companies who can finance fixed assets.
Similarly for an established franchisee looking for growth capital, Mezzanine Financing can be arranged through a venture capitalist, an ‘angel’ investor, a friend or family. Such investors are not looking for hard security to back up funding but will evaluate an entrepreneur’s management ability and strategy. In such deals the entrepreneur may have to relinquish part ownership of the franchise.
During ones search for a franchise, be sure to look for companies whose focus is on building a strong brand.
Canadian Franchises sell more than $100 billion worth of products and services every year making Canada the second largest franchise market in the world after the U.S.
There are over 1000 franchise systems operating in Canada, representing almost 76,000 franchise system outlets, employing a record 1.5 million Canadians.
Given that financial institutions and various levels of government recognize the value of backing such projects, there are now a variety of ways to fund a proven franchise model.
For many bankers, anyone who has made it through the franchisor’s screening process and credit check is worth taking a look at as a potential customer.
At present, one of the most popular ways to finance involves the federal governments Canadian Small Business Finance Act (CSBF). Under this program, the federal government in effect co-signs a loan with the franchisee for up to 100% of the financing needed, up to a maximum of $350,000. This benefits both financial institutions and borrowers. With the federal guarantee, the bank’s exposure is lessened, while the franchisee pays lower rates under such an arrangement, typically prime plus 3% for the term of the loan, which on average is five to seven years.
These loans are more liberal than traditional financing because they will usually cover not only fixed assets but also leaseholds, which have no residual value and can’t be resold. Formerly, security was required to finance such items.
What this sort of loan will not cover is working capital, the money needed to cover expenses such as payroll and inventory. Federal funding is also available through the Business Development Bank of Canada (BDC).
While the BDC is referred to as the ‘Bank of last resort’, it sometimes funds projects not accepted by the banks because the commercial banks must think of their shareholders, whereas the BDC’s mandate is to break even. It is also willing to look at longer terms than the big banks. BDC will finance up to $150,000 where the franchisees rate is approximately 4.25% - 8%, depending on the risk.
While government’s willingness to back loans is appealing, there is no getting around the amount of equity a franchisee is expected to put up when arranging financing.
Banks and franchisors expect anywhere from 30% to 50% must come from the entrepreneur’s net worth.
The CSBF and the BDC are there to help but they still want to see that you have some hard assets yourself. With fees, hard assets, working capital, ongoing royalty fees and central advertising costs, any less and the debt would be too heavy.
Once the fixed costs are covered, franchisees must also arrange some sort of fluctuating line of credit to cover their operating costs. One of the reasons a potential franchisee should have good cash flow projections mapped out, with the franchisor’s input, to explain how the franchisee intends to cover the ongoing costs, such as salaries and inventory, that are needed to keep a business working, given it will probably take at least six months to break even.
In many cases, banks also require a ‘Letter of Comfort’ from the franchisor, stating that the franchisor will buy back equipment and undertake to remarket the franchise unit should the franchise run into difficulty.
There are other options to financial institutions which are available to franchisees such as leasing companies who can finance fixed assets.
Similarly for an established franchisee looking for growth capital, Mezzanine Financing can be arranged through a venture capitalist, an ‘angel’ investor, a friend or family. Such investors are not looking for hard security to back up funding but will evaluate an entrepreneur’s management ability and strategy. In such deals the entrepreneur may have to relinquish part ownership of the franchise.
During ones search for a franchise, be sure to look for companies whose focus is on building a strong brand.