Making Sure Your Opportunity is Bankable
One of the most repeated pieces of advice given to emerging franchisors is to make sure that the first twenty franchise units have as few financial problems as possible. The strength or weakness of the initial franchisees will be what the franchisors will be reporting in their Item 19’s for years to come, and it has enormous long-term impact on the value of the brand. It can ultimately impact future franchisees’ ability to secure financing from banks, which often evaluate the overall brand when deciding whether to extend a loan to a franchisee.
So how can a franchisor help to ensure the success of those franchisees? While the financial health of new franchise units hinges on a variety of factors, being able to assess whether the franchisee is armed with sufficient working capital before opening is among the most important.
The first step in assuring that the franchisee is successful starts with the FDD, particularly with Item 7. Inaccurate or overly optimistic estimations of the initial investment often result in the franchisee not having enough cash to open the unit, or they result in the franchisee perhaps having just enough to open but without the post-transactional liquidity that would allow the franchisee to pay personal bills or respond to any unexpected operational costs. Because banks often look to the FDD to substantiate requests for business loans, it is important that the FDD reflect any trending higher costs to ensure that the franchisee can secure the necessary financing.It is also recommended that franchisors include the average breakeven measurements so that the franchisee can request an appropriate amount of working capital from their financing sources.
Furthermore, accurate estimated initial investment and breakeven amounts will better deter franchisees who cannot obtain the necessary financing to open a successful franchise unit. This can allow for a quicker and easier franchisee vetting process, wherein asset verifications can be obtained earlier and with fewer surprises.
It is also important that franchisees understand the variety of financing options available to them, as well as each of their consequences. SBA loans require collateral and, therefore, may not be recommended for franchisees looking to become multi-unit operators. A franchisee using a personal residence as collateral for the first unit, for example, would not likely be able to use it as collateral for future units because it is tied up in the first loan. Rollover for Business Start-ups (“ROBS”), on the other hand, is a method of obtaining liquidity for legitimate businesses and requires careful structuring so as not to incur unnecessary taxes or penalties. Franchisees should also be aware of the possibility of having a combination of financing sources so as to better balance their debt-to-equity ratio.
Finally, Discovery Days should be among the final interactions a franchisor has with a potential franchisee before executing an agreement. Asset verifications should be completed by this point to ensure that the franchisor isn’t expending time and resources on a prospect that ultimately does not qualify. Franchisors should consider educating prospects at Discovery Days about financing options and recommendations so that the franchise unit and the franchisor/franchisee relationship get off to as healthy and prosperous a start as possible.
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