Funding your franchise business

Daniel Cloete of Westpac discusses issues to look out for when funding a franchise purchase or set-up in the current economic climate

Every part of the economic cycle presents challenges and opportunities, and the current situation is no different. However, every cycle is different and the current high inflation, linked to some unique challenges coming out of Covid, is presenting some additional considerations for those looking at business funding.

When looking to purchase a business or doing projections for setting up a new business, in addition to doing normal due diligence you may also want to consider some of the factors below. These could influence the projections and debt servicing ability of the businesses and, therefore, how much funding might be available/affordable.

Key factors

In general, sales are holding up well, and may even be higher due to inflating prices or demand, but increasing cost pressures are affecting bottom line profitability negatively. If you’re buying an existing business, that means you need to consider the current cost realities and ask the right questions.

Some examples would be:

Rent. Many businesses are locked into CPI-plus rent increases. Given the high inflation currently, that could mean an increase of inflation plus 2-3 percent in rent this year. As this could be difficult to get back through price increases (given all the other cost pressures), the difference may come straight off the bottom line. This can have a significant effect on business profitability, and may even be the reason the business is for sale! Get your professional advisors to check this out when purchasing a business, or take it into account if signing a lease when setting up a new business.

Rising interest rates. The extremely low interest rates over the last few years created a situation where the rate became increasingly irrelevant, while the term over which the loan had to be repaid had a much bigger influence on cashflow and debt servicing ability. That all changed when the Reserve Bank started increasing interest rates – something which is continuing. Remember, though, that rates are still relatively low compared to historical levels, so profitable business models should still be able to afford an appropriate level of debt.

Increasing costs and the resulting drop in profitability is probably one of the biggest issues in obtaining bank finance. These factors include salaries and the minimum wage, rapidly increasing food costs in the hospitality industry, and rent escalations amongst others. Although price increases could partially off-set some of these increases, it may be difficult to pass on all of it without negatively influencing sales.

Sales. Given very low unemployment rates, sales have been holding up well. When looking at financials, you will need to consider if the latest sales numbers look stable or increasing due to rising prices, rather than actual volume growth. In a higher inflation environment, people will have to get used to taking that into account and use real vs. nominal calculations to analyse underlying trends.

Plan ahead

All the above would obviously influence the multiple that you would want to pay for an existing business, as well as any projections for the next financial period. Provided you take this into account when making an offer, there could be some excellent opportunities in the market.

Credit risk appetite. In a lot of cases the banks’ appetite for business lending has not changed much. Unlike the GFC, there is a lot of liquidity in the system, so the money is there to borrow. While Covid, lockdowns and supply chain issues have clearly impacted some industries like hospitality, tourism and retail more than others, many are now bouncing back – although getting enough employees is still a problem.

Disposable income. A dramatic increase in borrowing costs is set to hit many New Zealand households through 2023. Around half of all home loans will come up for refixing during 2023. Many borrowers will be faced with significant increases in debt servicing costs. In some cases, borrowers could see their mortgage rates rising by more than 3-4 percentage points. That will offset much of the boost from the strong labour market and accrued savings, and will certainly influence the disposable income of mortgage holders. The future direction of interest rate movements would dictate when this effect changes, which is dependent on getting inflation under control.

The benefits of franchising –financial imperatives

Whether you are looking to buy an existing business or set up a new one, franchising offers a number of benefits: proven business model, brand reputation, documented systems, training, group buying power, experience, support and benchmarking. Less obvious, perhaps, are the financial advantages which come into play at times like now.

• Buying a franchise means you should have a clear knowledge of the financial input required, including initial costs and working capital.

• Funding may be available for a franchise when it wouldn’t be for an independent business. For well-known and accredited franchise systems, it may also be possible to fund against the projected business income for new set-ups.

• There are recommended specialists for advice such as banking, legal or accounting who will have detailed knowledge and experience of the franchise in question and be able to give valuable advice.

• Because good franchises share information and benchmark performance, you can compare the financial performance and KPI’s like sales, Gross Profit margin, labour costs, rent and Return on Investment with others in the same (or similar) groups. This will enable you and your advisors to develop a much better understanding of the business, lower the risk, and facilitate information that can assist with a business plan and funding application.

See your specialist franchise banker as an ally

Obtaining bank finance might seem to be a big issue, especially for first-time buyers of small businesses in the current climate. In fact, it could essentially be a straightforward process, using the same information you need yourself to assess the business anyway. The better the information you have, the better able you are to make a decision.

Finally, one thing that the potential franchisee should remember is that he or she is the bank’s client – not the franchisor! It is therefore in the bank’s interest that its clients join a stable, profitable franchise system without paying too much for the business. Talk to one of our specialists to find out more.

About the Author

Daniel Cloete is the National Franchising Manager for Westpac. For more information, contact your local Westpac Franchise and Business Banking Specialist on 0800 177 007 or email: franchising@westpac.co.nz The information contained in this article is intended as a guide only and is not intended as an exhaustive list of matters to be considered. Persons entering into franchise agreements should seek their own professional legal, accounting and other advice.

Daniel Cloete, National Franchising Manager for Westpac in New Zealand