Finance facts: industry expert explains what you need to know

There are several options available to new investors, even though lenders remain cautious

The pandemic has resulted in increased redundancies, plus a whole host of people having a career rethink during lockdown. Many are considering franchising as a viable option for a new direction.

However, it’s a tough economic climate to start a new business because lenders are understandably being more cautious about funding the purchase price of franchises with so much uncertainty in the marketplace.

Shifts in lending policy

Normally, depending on the franchise and individual circumstances, the main franchise banks will lend from a 50/50 ratio of individual investment and funding up to a 30/70 split. But in recent months we’ve seen shifts in policy, where some are not lending at all and ratios have been revised.

Many banks have taken a generalist view on certain sectors, blanketing those franchises where trading has been most affected, such as retail, gyms and some van delivery franchises servicing office trading estates. What we’re finding is that a sound business case for an application is just not enough in some cases.

Scheme change

For potential new franchisees, the situation has been compounded by the cancellation of the Enterprise Finance Guarantee scheme at the start of lockdown in March. This scheme was designed to support people looking to start a business, but who didn’t have enough equity in their property to allow them to gain sufficient finance.

The EFG programme was suspended and the Coronavirus Business Interruption Loan Scheme and the Bounce Back Loan Scheme were introduced. However, these new initiatives were aimed at supporting existing businesses rather than start-ups. So where does this leave potential franchisees?

What type of borrower are you?

It makes a significant difference if the potential franchisee is a secured borrower rather than an unsecured one.

Currently, tenants or anyone without equity in their home will only be able to borrow an unsecured loan of around £25,000-£30,000 from the main franchise banks to invest in a franchise. Previously, the EFG would have helped provide security for higher amounts of funding. Now, for unsecured borrowers options are restricted.

For those who do have equity in property, it’s possible to borrow against this. However, often it’s not as much as potential franchisees think. This is because all banks write back the property to 70 per cent of its valuation, then subtract the remaining mortgage amount to give the equity value.

Imagine your home was worth £120,000. A bank would write this back to 70 per cent of its value or £84,000. Say you had a £50,000 mortgage remaining. £84,000 minus £50,000 leaves only £34,000 equity, which the bank can lend against.

The asset finance route

To raise further funding - for vehicles or equipment, for example - asset finance can be an option.

For unsecured borrowers, asset finance companies are also being more cautious. Some are not dealing with tenants at all, while those that are still lending are limiting their individual deal amounts. However, it’s easier to secure asset finance for homeowners. This doesn’t mean you have a second charge against property, just that you are considered a safer risk.

Previously, asset finance companies accepted low deposits, such as five per cent or even one payment in advance. Lenders now regularly require larger deposits, which can be anything from 10-30 per cent. This has an impact on the level of investment you need to get your franchise started.

In many cases, asset finance companies have also downgraded their tier system. Normally applications fit into certain tier levels, often referred to from one to three according to their risk level based on certain parameters.

We’re now seeing some companies stepping clients down a tier automatically. So previously an application that would have been a grade one is now considered a grade two. The higher the risk profile tier, the more the deal needs to be restructured and usually the higher the interest rate charged. We have recently seen some gym franchisees being quoted as high as 20 per cent APR interest on asset finance for essential equipment, even with a 15 per cent deposit.

Choosing a broker

The fact is anyone looking at investing in a franchise needs significantly more of their own capital to invest than they did nine months ago. Brokers need to think outside the box to help applicants secure the borrowing they need and applicants need solid, well researched and independently validated business plans.

For successful franchisees, finance may well end up coming from several different sources.

Other loan providers and the Start-up Loans scheme can be considered to make up the shortfall in the investment required. Here, the choice of broker is important, as it’s not as simple as sending off asset finance applications any more.

Now you need a broker that understands all aspects of your business plan, company structure and wider personal circumstances, so they can explore beyond the ‘normal’ and restructure your project to deliver the required levels of funding you need.

It’s vital you locate an independent supplier who has all these skills, is not limited in their approach and who can assess the market to get you the deal you need.

If you use different brokers or suppliers for different elements of the project, it’s critical you do not draw down on any one solution or commit to things like premises leases until all the required funding elements are approved. Otherwise, you’ll be at significant risk and may be tied into financial commitments before actually being able to start trading.

Going beyond the boundaries

d&t offers independent business planning, accountancy and funding advice, providing the full range of services you need in one place and connecting franchisees to the much-needed finance they require to start or grow their business.

In the past six months, we’ve written business plans and worked on projects that have supported funding applications for well in excess of £3 million of franchise investment.

Given the current economic climate and individual circumstances, some applications have not been as straightforward as others. However, even in the most challenging sectors, we’ve been able to secure funding and help ensure the franchisee gets their business up and running.

In these cases, we’ve needed to go beyond the boundaries of a normal broker. As chartered accountants, we’re able to see the bigger picture and, for example, look at how the structure of a business can be changed to generate further routes to lending or strengthen the likelihood of applications being approved.

The good news is that despite the current challenges brought on by the COVID crisis, the franchise industry is still moving forwards. Deals are still being done and candidates with well-researched business plans are getting the funding they need to finance their new careers in franchising.

The author

Phil Archer is asset finance manager at d&t, award-winning chartered accountancy and business advisory specialist.