Financing alternatives and considerations

Financing alternatives and considerations

Raising capital for a restaurant or fast food franchise can be frustrating if you’re not properly prepared. Here’s what you should keep in mind..

Start by gathering knowledge about the economy you’re operating in. Your success won’t be reliant on faraway stock exchanges and abstract ideas; it will come down to your customers’ pockets and your ability to survive and repay your loan.

“If you’d asked me about the market outlook for the food sector this time last year, I would have been very positive,” says Nedbank’s head of franchising Mark Rose. “A number of franchisors had high growth aspirations and a lot of confidence in positioning their products in emerging Financing alternatives and considerations markets. But in January this year, these plans came under abrupt review.

“There are a number of reasons for this caution: power outages, relatively high interest rates, the impact of volatile global markets on our economy, falling stock markets, reduced business confidence, inflation and the weaker rand. It is more expensive to buy imported equipment, for example. Operating margins are also under pressure and it’s becoming harder to respond by growing volumes because consumers are also being squeezed and don’t have as much money to spend on eating out.”

Power cuts hit fast food outlets particularly hard as these stores generate the majority of their turnover during the day. They feel the effects of the power outages for more than a few hours because their customers tend to leave the malls and office precincts and don’t come back for the rest of the day. Some of the banks do provide finance for generators, but the big shopping centres don’t usually allow food outlets to operate their own generators.

Room for growth in food

Does this mean you should give up your dream of owning a food franchise? Not at all, says Rose. “Seen more broadly, South Africa is full of opportunity. There are only about 500 franchise concepts and 30 000 outlets in this country and therefore plenty of room for growth. Provided we can show that South Africa is a viable destination for investment, we should see more international brands coming here as their own markets become saturated.”

If you are looking to enter this sector you will need to do your homework. Spend time talking to the experts, including your banker and find out what your bank will want to know about you and what you should consider when applying for finance. Look carefully at your business plan and focus on areas such as cash flow.

When applying for finance, the banks will normally expect prospective franchisees to contribute a minimum of 40% unencumbered cash towards the total investment cost, before they will consider financing the balance. This percentage will be higher or lower, depending on the bank’s arrangement with the franchisor. The financing solution will depend on the brand, type of concept, typical profit margins and debt serviceability.

Your financing options

What are your financing alternatives? Generally speaking, traditional bank financing, equipment financing or private equity (friends and family, “angel” investors and institutions) are your options when looking to finance the purchase of a franchise.

Many of the banks also offer tailored packages, including finance for new store acquisitions, existing store resale transactions and “revamp” financing (when franchise owners are upgrading stores). Franchise Agreements usually stipulate that franchisees set aside a monthly contribution for revamps, but finance is available if this doesn’t cover the costs.

In South Africa franchising is viewed as an important route to black economic empowerment, explains Rose, and these new entrants don’t always have a 40% down payment. Many of the banks have therefore come up with ways to finance BEE franchisees. “Nedbank for instance may agree to finance at a higher level after consultation with the franchisor and franchisee,” explains Rose.

These deals are supported through specialised and flexible financing structures where, for instance, the franchisee pays only the interest for the first year or longer and not the capital. This helps to get a business off the ground, as it usually takes about two years to become fully established and start making sufficient revenue to repay back the capital.

The relaxed conditions for BEE financing could, however, see the franchisee’s debt levels rising too high, especially if interest rates continue on an upward path, advises Rose. So test the numbers thoroughly before concluding a deal.

Franchisees can usually expect a reply to their loan applications within a week, if all the standard requirements outlined by the bank have been met. While lenders do have pre-approved guidelines, applications will still be assessed on their own merits. Factors such as the different financing needs of rural and urban stores, market demographics and buying power differences, will be taken into consideration by the banks, explains Rose.

Financing assets

As for sustaining business growth, one of the areas you need as a franchisee is the right financial vehicles to structure debt. “You shouldn’t finance assets like equipment on an overdraft, for example, or stock on a three-year term-loan. An overdraft is there for short-term working capital requirements. The appropriate vehicle for movable and fixed assets in a business is a medium to long-term loan,” says Rose.

Some businesses experience financial difficulty because of a mismatch of financing options. “For example, if you are borrowing R1.6-million. Perhaps R100 000 of that would be an overdraft to cater for short term working capital requirements, R10 000 may be a letter of guarantee issued in favour of the landlord in which the store is being leased from.

“Another R100 000 could be for a delivery vehicle, to be repaid over 48 months, and the balance may be a five-year medium term loan for the financing of equipment. The type of loan must suit what it’s used for,” explains Rose.

A basic mistake many people make is that they don’t ask enough questions about the franchise concept. “The franchisor is obliged to give you a disclosure document that tells you a number of things like, how long the franchise has been established, what support they will provide, how they select sites, and what you get in return for paying a management fee.” The next obvious thing to do is to talk to existing franchisees. “Ask them how it’s really going,” says Rose.

“Investigate thoroughly before making a decision. Then demonstrate the underlying assumptions used in compiling your business plan when you approach the bank for financing. Often, we find that a consultant has prepared the business plan and the person applying for the loan can’t explain how certain conclusions in the plan were reached.” The plan should be concise, he says, but must include all the salient features that are most critical for a bank to consider when assessing a financing request.

Timing is crucial

Don’t leave it to the last minute to approach the bank for financing. If you’ve been accepted by the franchisor and are about to sign the offer to purchase, you should already have engaged with the bank to find out what financing and other banking solutions are out there. This will alert you to things you need to consider.

“You should insist on good service from your bank,” he adds. “If your application for finance has been declined, you have every right to ask why. Don’t be shy – find out the reasons. And if you know you’re a low risk, you’re entitled to a competitive finance rate.

“The big thing is to decide whether you are 100% sure that you are the right sort of person for franchising,” Rose says. “It’s not glamorous, especially in the food sector. It requires long hours of hard work, it demands sacrifices and it has a huge impact on family life. You must be sure you have the right character and makeup. Through hard work, dedication and commitment the rewards can however be significant.”

The banks also look more favourably at applicants who plan to be owner-operators. Leaving the task to someone else just doesn’t work in many cases, particularly in the initial start-up stages.

ROSE’S TOP TIPS

  • Decide if franchising is right for you
  • Investigate the franchise concept thoroughly
  • Think through the business plan carefully and understand it
  • Factor in the cost of debt and the potential for that to rise in future
  • Approach the bank in good time
  • Demand good service