The amount of money it takes to transform an idea into a business depends on factors ranging from the nature of the product or service to the aptitude of the businessperson. Traditionally, it has been hard for small ventures to obtain capital. This is especially true in the start-up phase, and has been magnified by the increasing cost of money in financial markets, which in turn has constricted the flow of money into the small business realm. Planning has never been more critical, if for no other reason than to allow you to compete against others for financing.
To their credit, franchises have suffered less from the credit crunch than other small businesses because franchise outlets are widely considered less risky than independent enterprises. More specifically, the main reason franchisees have enjoyed success with both public and private sources of money is that much of the preparation has already been done for them by the franchisor – that, among other things, is what you pay for when you buy a franchise.
Individuals buying into existing, proven franchises are in the best position of all to approach financing sources, while those looking to be one of the first franchisees of a new franchise will be subject to a little more scrutiny.
This advantage in no way implies that franchise businesses are risk-free. Being well prepared when you seek start-up financing, or any kind of financing for that matter, is the key to alleviating the doubts lenders exhibit when the owner of a small business comes knocking on their door. In today’s marketplace, franchisees are having better luck with financing than independent small businesses, but you cannot afford to take it for granted.
The moneys proposed use is the primary question in lender’s minds. Banks, for instance, will not want to make a loan that puts them in the position of an investor – they prefer to be financing sources only. They want to stay liquid, which helps them minimise their risk. As a businessperson, you must always have a clear understanding of how much cash you need at any given time and how you propose to use it, even when you have the strength and solidity of a franchisor to support you. By doing this, you can determine the best source of money to finance your business.
There are infinite sources of financing available to help you launch the franchise of your dreams. However, operating a franchise without reserves and blinding yourself to unexpected financial problems can lead to disaster. A good rule to remember: Never invest more than 75 percent of your cash reserves.
Most importantly, remember that the price of a franchise does not always reflect the actual cost of the business itself. Additional costs can be down payments on the land, building, equipment, fixtures, and signage, and can cover stock, leasehold improvements, training, opening advertising and promotional costs, administrative costs, and even sales commissions.
Be sure you understand the requirements of your cash investment. You will need a “pillow” of working capital to properly guide the business through its ups and downs. If you do your homework thoroughly, and remember that financing is the most important sale you will ever make, then you will be head and shoulders above the competition.
Evaluating your financial situation
Keep in mind that only some franchisors (those who issue financial disclosure statements) make financial models available to prospects. Most are unwilling to claim that a franchisee is going to make at least X amount of income or attain a certain profit margin. Even when they do, you should check their calculations and come up with your own projections. Most prospective franchisees do this while building their business plans.
As a franchisee, you would use financial projections to help gauge things like development budgets, cash flow projections, profit and loss forecasts, etc. You can also call up existing franchisees and talk to them to try and build some consistent projections for your area.
In terms of self-evaluation, even though you intend to purchase a franchise, you are still going to assume a certain degree of personal risk to start the business. Once you accept that, you can start looking at other ways of supporting your startup.
First-time business owners frequently use their personal funds to get their business off the ground. This does not mean that once you are in business, you won’t need additional capital. Business owners use many techniques to obtain personal loans for business financing, both during and after the initial startup. You can borrow from individuals, institutions or your franchisor, using a loan secured with collateral or an unsecured loan made on a promise or contract. The latter is the most advantageous to you as a borrower because you don’t risk losing anything tangible. Your promise to pay is made on the basis of your past debt paying performance.
If you are already inundated with debt, you may not be able to get the financing you seek, and if you can, it won’t be at a favourable rate. In this case, you’ll have to look at equity financing as an option. The difference between equity financing and a standard loan is that you sacrifice a portion of your business, profits and possibly some control when you finance with equity.
Also, it is more difficult to locate someone to buy part of your business as a partner, limited partner or perhaps a shareholder of your company. Equity money does, however, at least allow you to proceed with your business start-up. You can also use it to go through a growth period or expansion.
Any long-term activity that will bring in profits over a period of years can qualify for long-term debt, with lower monthly payments and possibly lower interest rates.
Cash flow projections
Begin planning your financial requirements by answering a few fundamental questions:
- When are you going to repay the money? (Different situations will also determine what type of money you need – equity or individual loans.)
- How much do you need? (The use and scheduling of the financing will depend on the amount that you need.)
- Can you afford the cost of the money? (Lenders charge a wide range of interest rates and fees for the use of their money.)
Lenders generate revenue by charging interest on the principal amount of the loan and charging fees for the transaction. Interest can represent a substantial cost, depending upon the rate and terms you secure. Even if your rate is low, it is essential for you to develop an accurate profit and loss projection, covering at least three years, and adding in the cost of the interest on the money you borrow.
A well-compiled cash-flow projection will indicate whether or not you can truly afford the loan. Despite the value of cash-flow projections, many businesspeople don’t prepare them on a regular basis. They might prepare a profit and loss statement, or a balance sheet, but they often lack a cash-flow projection. When raising money you have no choice. Fortunately, these financial tools are not terribly difficult to put together, and they are useful to have at any time of the year.
The interest you pay will show on your profit and loss statement, but the principal payments will appear on your cash-flow projection. This is usually a large item, and sometimes it is overlooked when people are writing their plans. You can make simple projections yourself, or give them to an expert. You will find it advantageous to prepare a written summary of your projections every six to twelve months.
Your banker is going to look at these projections to make sure that you can repay the loan from the profits of the business. The banker is also going to check the cash-flow projection to see that you have enough to cover your living and necessary expenses.
Keep in mind that it may take 12 months or more before you can break even, meaning your income matches your expenses. Of course, some businesses can go into a location with heavy foot traffic (such as a shopping centre) and begin to generate a positive flow of cash immediately. Using the advice of suppliers and other industry contacts, you’ll want to estimate how soon you can realistically predict expenses and sales in order to estimate when you will break even and start having a positive cash flow.
There is another critical financial sheet to develop before embarking on a search for start-up financing – the balance sheet. The balance sheet simply shows your total assets and liabilities, and by subtracting the latter from the former your net worth is estimated.
Setting the financial planning wheels in motion
The experienced businessperson will know that financial planning is only part of the package. The rest of presenting your business and the franchise concept involves the use of your communicative skills to give the impression that the franchise in which you plan to invest is a profitable and stable business.
Bankers, investors and suppliers are also going to be looking to see what kind of person you are. Are you the kind of person who repays debts? Do you have a reputation of stability? If you’ve had trouble in these areas, it doesn’t necessarily mean that you can’t go into business. But wherever you have had a problem, you should have an explanation for it.
When you raise money, you become a salesperson by default. Just as in any selling situation, you want to take care of objections as they arise to avoid them coming up later when making the close. If you have some unusual element in your business plan worth noting, then footnote or comment on it in the plan as a way of meeting the objection before it arises.
When evaluating your financial situation, first take stock of your personal and business assets. If you’re tight on cash, ask yourself how you can convert the assets to cash by selling them. It doesn’t matter if they are personal or part of the business proper; they’re all assets. Make a careful list of everything valuable you own. Analyse the situation to see what you might be able to sacrifice.
Go through and look for problems in your personal expenditures, or places where you might be spending more than you should. Identify where you might be able to cut back. You’re going to show a personal statement to banks and other prospective funding sources, and they will want to make sure you can live within the income you generate now, as well as the income you expect your franchise to earn.
What investors look for
Whether it’s a small loan, a personal loan, or your first bank business loan, the lender will be considering it as if it were a personal loan. Your ability to attract money thus depends as much on their perception of your character and the franchise concept as on the completeness of your paperwork.
Investors look at:
- Stability: They’re going to check to see how long you’ve stayed in jobs, where you’ve lived, or how long you’ve been in a certain neighbourhood. None of these items by itself would keep you from getting a loan. They look at the overall picture, so try to make everything as positive as you can. If there is little evidence of stability, then you want to be prepared to answer any questions that may arise. If you’ve moved around a lot for one reason or another, or you’ve changed jobs for better opportunities, have a brief, logical explanation ready.
- Income: Not only is the amount of income you earn important, but so is your ability to live within that income. Some people earn $100,000 a year but still can’t pay their debts, while others budget nicely on $25,000 a year. Most lending institutions look at your earnings and the way you live within that income for a very good reason. If you can’t manage your personal finances, the odds are that you will have similar trouble managing business finances.
- Debt Management Track Record: Lenders will look at how well you’ve been able to pay off your debts. What’s your track record? If you have a credit card, have you paid it on time? Did you pay your car loan on time? House payments? Are you ever late with your rent cheques?
How well will you be able to demonstrate that you paid off your past debts? If you have a record of late or non-payments, repossessions and so on, then you should get these squared away before asking for a loan. Incidentally, cleaning up these obligations is good training for running your own business since it takes discipline to be successful. If you’ve got some problems in this area, have an explanation ready to satisfy these people.
You are probably aware that anyone who receives a credit application from you can have your personal credit report checked on computer almost instantaneously. You also have access to these records, so take advantage of it and arm yourself with the same information.
It is important that you tie up any loose ends before you apply for your loan by disputing any erroneous information you find and closing any accounts you no longer use.
