Banking and Finance: A franchisee's guide to raising finance

An investment in a franchise can be one of the most significant purchases a person will make. Lloyds TSB Head of Franchising Richard Holden examines the lending options available, and the other benefits a bank can provide to a prospective franchisee

Franchising is generally regarded as one of the safer ways to start a business, but that's not to say there are no risks. It is essential that anyone considering investing in a franchise researches the market fully and gets all the necessary advice before making a commitment.

Banks are always a good place to start. They will be able to provide general guidance about what franchising is and how it works. They will also be able to help you decide whether franchising is the right option for you, think about the questions you should be asking a franchisor, help to get your business started, and provide background information on major franchise systems and the finance options available.

A bank will require from you a comprehensive business plan to set up a bank account and consider financial support for your business. Any lender will want you to demonstrate that you understand your chosen market, that you will be able to manage the financial commitment and that you will be able to make a living from the business.

A business plan is a written document that provides an overview of the business, objectives, market, management team and financial projections. It is often assumed that a business plan is just used to secure external funding for the business. While this is an important benefit of producing a business plan, it can also assist with the management of the business such as monitoring its ongoing performance against the original benchmarks and the identification of areas for development.

The plan is a working document and should be regularly reviewed and updated as the business develops. Presentation of the plan is important to create maximum positive impact and you should practice delivery of your plan before speaking to a lender so that you come across professionally.

There is plenty of professional advice from banks, Business Link advisers or accountants to help write a business plan. For instance, the bank will be able to provide a business plan template detailing what information should be included in the document. Also, a good franchisor will help you develop an effective business plan. It may even be able to give you an indication on the trading performance of other franchisees within its network. However, a word of caution: figures provided about past franchisee performance are no guarantee of how your business will perform and careful planning and research of your chosen area is important.

Your investment level will depend upon your chosen franchise opportunity. You may be able to finance the investment from your own resources, however if you need to borrow funds banks are the most common source of finance. The level of finance available from a bank will depend upon the strength of the franchise system and your business plan.

Typically, banks will lend up to 70 per cent of the total franchise set up costs, including any working capital requirement. For less established franchise systems the maximum finance available maybe reduced to 50 per cent.

The set up costs and the purchase of business assets should be financed by way of a term loan. The maximum term of the loan will not exceed the initial length of the franchise licence.

Interest rates can be fixed or variable and a capital repayment holiday for up to two years may be available.

Working capital for running the business is usually financed by way of an overdraft facility. Overdraft limits are agreed for an initial period of up to 12 months and reviewed on expiry for renewal for a period. Cash flow varies widely from business to business and working capital is provided to bridge the period when the business needs to pay suppliers for stock and the running costs of the business until its customers pay for the product or service.

A franchisee must have a cash stake in the business and usually the bank will require security to cover the agreed lending. This will typically be a legal charge over a residential property, although commercial leasehold or freehold property, a debenture, life or endowment policies with a surrender value, a portfolio of blue chip shares, cash held on an interest bearing side account and personal guarantees may also be considered.

The Small Firms Loan Guarantee Scheme may be an option if adequate security is not available. The scheme is a joint venture between the Department of Trade and Industry and a number of participating lenders. Its purpose is to provide finance where a lack of sufficient collateral to secure a loan is available for an otherwise viable business proposition. The DTI will guarantee the loan under the scheme for 75 per cent of the outstanding amount. The borrower pays a premium to the DTI and interest rates are usually higher than a fully secured loan.

Other forms of finance are also available from banks, including factoring which is basically debtor book finance to assist business cash flow.

The factoring company will advance funds up to 90 per cent of the debtor book in advance of the invoice being paid. The remaining balance is paid to the business less the factoring charges once the invoice has been settled.

Business cash flow can also benefit from the use of business charge and credit cards. Banks can also support the purchase of vehicles and business equipment and machinery through Asset Finance. It is advisable that you keep a reserve of at least six months' expenditure in case the business takes longer than anticipated to meet projected income levels. There are dangers of borrowing too much money and struggling to meet the financial commitment, however there are also dangers of being under-capitalised, so careful planning is necessary.

Ask the banks that have a dedicated team of franchise experts, such as Lloyds TSB, about the franchise opportunities you are researching. Banks do not endorse or recommend any particular franchise and will give you independent advice on the strengths and weaknesses of the opportunity you are looking at.
They can also let you know whether preferential banking terms will be made available and what level of finance you would be able to get to support your plans.

Richard Holden is Head of Franchising at Lloyds TSB Bank.