Bank requirements in franchise acquisition
Franchisors and franchisees have to make various financial considerations when engaging in a franchise relationship.
Today’s article continues exploring franchisee financing from the banker’s angle, in markets where franchising flourishes.
Fourth are the franchisee’s banking details. This forms part of credit risk assessment because it allows banks to see how well the franchisee has been conducting his/her existing bank account and if there are other loan accounts with large sums still owing. It is common for the bank to ask the franchisee to move all banking activities to the bank once funding is approved.
This helps the bank keep a close eye on the franchisee’s finances to enable it pick up any red flags before they grow to unmanageable levels.
Fifth is the franchisee’s own contribution into the business. The franchisees own contribution is a sign of commitment to the business.
Banks are reluctant to fund the full amount and expect the franchisee to provide a percentage of unencumbered funds of the total cost, normally 50% for franchise businesses.
Sixth is collateral/security. The bank requires security. It is something they can fall back on in case of a situation where the borrower is unable to meet repayments on the loan. It also shows commitment to the business.
Landed securities are more attractive to banks, but other forms of security such as fixed assets like vehicles and equipment, cash covers, bonds, treasury bills are also sometimes acceptable.
Seventh are the audited financial statements. Audited financial statements demonstrate past history.
This is particularly required if an existing outlet is purchased. It is used by banks to determine the Net Asset Value of the entity and whether such as entity is solvent or has contingent liabilities and warranties.
It reflects the profit history of the outlet being sold and if the seller is asking for a fair price.
Eighth are projected management accounts. These depict how the business will look like in the future putting into use the finances sought.
Income statements, balance sheets and cash flows are projected for at least three years or for longer periods to cover the loan duration.
Of particular interest to the bank are the assumptions on which these projections are based, hence a sensitivity analysis is required to show what would happen in each year should the assumptions change.
Also, profitability ratios are key as they show whether the business will make enough profit after paying off all expenses, an indication of whether the business is worth the effort.
Ninth are external funders such as equity investors. A franchisee business that has attracted structured external equity investors, particularly equity funds, stands a better chance of getting loan approvals.
This is because external funders reduce the credit risk of the business, ensure better corporate governance and are themselves working to ensure they recoup their investment and make a profit over the investment period, hence the lower likelihood of the business being unable to repay approved loans.
Finally, is accreditation. In franchise-advanced markets, banks provide accreditation to a franchise system based on the strength and success of the brand, their financial standing, the kind of support and training given to franchisees etc.
The Disclosure Document, Franchisee Agreement and Operations Manual are all important documents banks may require for accreditation.
In South Africa membership of FASA is very important to banks when determining whether or not to give accreditation to a franchise system.
The benefit of being accredited is that banks are more likely to finance accredited brands.
The writer is a Franchise Consultant helping indigenous East African brands to franchise, multinational franchise brands to settle in East Africa and governments to create a franchise-friendly business environment.
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