View from the inside: Affording a franchise - A serious business

An unrealistic business plan resulting in inadequate funding is a recipe for disaster for your business, warns Swisher Chairman Jeffrey S Keen

The starting point of all business ventures is the drawing up of a business plan. This calculates the funding requirement. One of the many advantages of franchising is that a reputable franchisor has a well-tried business model and comprehensive business plan that can be readily adapted by individual prospective franchisees. For example, at Swisher we have a master spreadsheet which is updated with conservative figures based on a six month moving average to reflect what has been happening in the network. This creates a template on which potential franchisees can base their own business plans.

In the majority of cases bank funding is required to buy a franchise. In fact, even in those few cases where prospective franchisees have sold a substantial business and have liquid cash, we recommend using bank money. Entering into any business contains an element of risk (even though in franchising the risk element is greatly reduced), so it is better to keep available cash invested, even if it means using cash on deposit as security to the bank.

Therefore the importance of a good business plan cannot be overemphasised. Many prospective franchisees have never produced a detailed business plan and approach it with apprehension, so a good franchisor should spend time explaining the intricacies of the business model.

However, a good franchisor is not only interested in the business plan aspects, but should be equally concerned about how the prospective franchisee and their family will live and survive over the initial years, until the franchise business has sufficient profitability and cash flow to draw out living expenses. At Swisher we will discuss current monthly expenditure on food, mortgage, entertainment, holidays, etc.

It is not uncommon to find that a prospective franchisee is living off his capital. During this time the prospective franchisee is evaluating the franchise, completing due diligence, waiting for bank funding, receiving the necessary training from the franchisor, and acquiring premises, start up equipment and vehicles. Therefore there is an element of capital erosion. The important point to remember is that usually the key date is not when the bank sends a letter confirming the loan, but the actual drawdown date when the cash is in the bank and the prospective franchisee can buy their franchise. The key issue to be addressed here is that at the end of any capital erosion the franchisee has enough liquid capital to afford to pay for 30 per cent of the negative cash flow of the proposed business venture (i.e. the balance of the bank funding).

In the real world, the day after the business plan has been completed it is out of date. As always in life, things may not work out to plan and can be worse than expected. The inevitable end result is that the cash flow could be adversely affected, which could mean that more funding is required. Going back to ask the bank for more money usually produces a negative response, which is why contingency planning is important both in writing the business plan, and in estimating personal living expenses to cover the first few years.

There is an old saying which applies: 'Turnover is vanity, profit is sanity but cash flow is reality'.

As many prospective franchisees have not had experience of dealing with banks and negotiating the best deal, a good franchisor should facilitate this. In the UK the main banks understand franchising and have specialist franchising departments. For example, at Swisher if a prospective franchisee meets our extensive selection criteria and we have approved their business plan, we introduce them to the franchise department of an appropriate bank.

Although a good franchisor can give considerable assistance, the bank will want the confidence that the prospective franchisee can produce a business plan and has the ability to negotiate funding.

For prospective franchisees of British Franchise Association members in whom the banks have confidence, up to 70 per cent of the total negative cash flow (that is all initial investment and working capital) can be lent. The first question any bank will ask following a request for funding is: what security can you offer? Frequently the security offered is the main home and this is another reason why Swisher insists that partners and spouses are part of the detailed financial planning that Swisher undertakes before endorsing any introductions to a bank. For security purposes, banks usually will take 80 per cent of a recent conservative valuation of the house, from which is then deducted the current mortgage. If this figure is greater than the loan required from the bank, then this is considered to be sufficient equity for security purposes.

If the applicant has insufficient assets then the DTI Loan Guarantee Scheme is suggested, provided all other criteria are met. This is a brilliant scheme for funding British franchises and the only downsides are the delay while a civil servant stamps an approval form and sends it back to the bank. Banks will not usually give a written commitment until they have received this form back as approved. The other minor disadvantage with the DTI scheme is that the rate of interest may be slightly higher and there is also a relatively small premium to cover the DTI scheme.

Once the franchisee is up and running, it is very important that business plans are not put in a drawer and left, but are actively monitored. A good franchisor should be an essential part of this process. For example, at Swisher a new franchisee can expect a detailed business review after three months and this formal process is repeated every three to 12 months depending on the experience of the franchisee. This is in addition to all the one-to-one support and group training.

Profits do not happen by chance, they must be fought for. At Swisher formal business reviews, senior managers sit down with the franchisee and go through their management accounts line by line. We have a standard system for converting business plans into budgets and budgets into management accounts, so that the management accounts format of all franchisees is identical. This enables the franchisee to benchmark and ascertain the network's best practices by comparison. For each line of the profit and loss account and balance sheet it is relatively easy for the experienced manager to pinpoint those areas that need management attention to steer the franchisee into producing optimum growth and optimum profits.