Alternative financing models for franchisees: What franchisors are using and why

At a recent gathering of the Franchise Management Forum attended by leading brands from around Australia, senior franchise executives discussed the challenges of obtaining traditional bank finance for suitable franchise candidates.

The forum, held on June 6 and jointly organised by the Franchise Advisory Centre and Griffith University’s Asia Pacific Centre for Franchising Excellence, regularly explores topical issues, and financing for franchisees was one of the hottest issues at the event.

In response to the challenges of raising bank finance for new franchisees to join their systems, many franchisors have developed partial or fully-alternative financing models.

The following summary from the forum broadly outlines these alternative financing models across nine major subject areas:

1. Joint ownership models

• Franchisors take equity in the new outlet along with the franchisee.
• Franchisor equity may be as high as 70%.
• Franchisees pay out the franchisor’s equity according to a pre-agreed formula progressively during the initial term of the franchise.
• At the end of the first term, the franchisee then owns 100% of the business.

2. Vendor financing

• Franchisee is required to contribute an investment amount (e.g. minimum 20%).
• Franchisor recovers loan from franchisee via increase above normal franchise royalty (e.g. an extra 2% of turnover), or other method.
• Vendor financing considered for greenfield sites only and not resales (unless they are resales of company-owned outlets).

3. Family financing

• Allowing the franchisee to use money provided by their parents to fund part or all of the franchise cost.
• Franchisors divided on how this should operate.
• Some were not too concerned about parental funding, others insisted that the money had to be gifted from the parents to the children, and that there be no loan agreement in place.

4. Variation of franchise term

One system reported it was considering reducing the length of its initial term to reduce the size of a franchisee’s initial investment. However, it still needed to consider this in the context of property leasing and store fit-out costs.

5. Bank accreditation – franchising

A number of systems reported that they actively sought to become accredited under specialised bank franchise lending models that provide up to 60% of the investment required without real estate security. (However, franchisors with investment costs below $200,000 may not qualify for bank accreditation.)

• Accredited franchisors are accredited with at least one bank, although many indicated a preference to be accredited with multiple banks where possible.
• All accredited franchisors acknowledged that it is important to proactively manage the relationship with any accrediting bank.
• Some concerns expressed at inconsistency from banks due to changes of personnel, policies or both, which can disrupt banking relationships.
• Complexity of the franchisor’s business model can also be a barrier to obtaining bank accreditation.

6. Bank accreditation – industry specialisation

Franchisors in health and other highly specialised industries may have a separate bank accreditation option via specialised industry lending units within the major banks.

7. Discounting of initial franchisee fee

Reducing the franchise fee component (i.e. payment for access to franchisor’s brand and IP) to reduce the cost of the total franchise investment.

8. Trade franchisees up from smaller investments

A very small number of franchisors had good candidates who had invested in other franchises, built up their equity and sold these businesses before returning to the more expensive franchise, which they could now afford.

9. Reduction of establishment costs

Some franchisors reported that they are reducing their overall franchise investment levels by finding more cost-effective options for store fit-outs and equipment. This did not necessarily entail reducing the size of a store footprint, although this was also acknowledged as being a way of reducing establishment costs.

These nine broad responses to the challenges of obtaining bank finance are not a definitive list. It should also be noted that banks are still lending to small businesses and franchises, but post-GFC are now applying more stringent criteria to reduce the risk of bad loans.

No matter what financing method chosen, franchisees will succeed if their system is robust, their market position is credible, their franchisors are committed to their success, and the franchisees themselves are fully committed to the profitability of their businesses.

The Franchise Management Forum will be followed on November 21 this year by a Franchise Marketing Forum, to explore common marketing problems faced by franchise brands.

Jason Gehrke is the director of the Franchise Advisory Centre and has been involved in franchising for nearly 20 years at franchisee, franchisor and advisor level.

He advises both potential and existing franchisors and franchisees, and conducts franchise education programs throughout Australia, and publishes Franchise News & Events, a fortnightly email news bulletin on franchising issues and trends.