How franchise finance works

The major banks and some specialist lenders keep a list of franchise systems they have reviewed and accepted. To get on the list, a franchisor opens its books to the lender: network size, years in operation, store level profitability, closure and dispute history, the strength of the franchisor's own balance sheet, the training and support given to franchisees, and the standard franchise agreement. The lender ends up with performance benchmarks for the system, such as what a typical store turns over and what it costs to run. That data is what lets a credit assessor lend against a business with no bricks and mortar behind it.

Accreditation is lender specific and it changes. A system can be accredited with one lender and not another, and lenders add and remove systems as network performance moves. Accreditation also sits with the system, not the applicant. The buyer still has to pass the lender's own tests on character, credit history, experience, contribution and serviceability. Franchisors know which lenders have accredited them and at what level, so that is one of the first questions to put to the franchisor's recruitment team.

For an accredited system, lenders commonly advance around 50% to 70% of the total set up or purchase cost without property security. Established resales sit toward the upper end and new sites commonly a little lower, up to about 65%. The security is a general security agreement over the franchise business plus director guarantees. Under some accreditation arrangements the franchisor also agrees to help resell a site that is failing, which lowers the lender's likely loss. The franchisee contributes the remaining 30% to 50% from cash or equity.

Where the buyer has property, the picture changes. With a mortgage over a home or investment property, lenders will consider funding up to 100% of the franchise cost, and the term on the property secured portion can run far longer than a loan secured by the business alone. Many franchisees use a blend: a business secured loan to the accredited limit, plus a smaller property secured loan for the balance. The options are compared on the page about secured vs unsecured loans to buy a business.

A franchise is a right to trade for a fixed period, so the lender wants the loan repaid inside that period. Business secured franchise loans commonly run 5 to 10 years and will not extend past the expiry of the current franchise agreement, and some lenders will not count renewal options. A resale with three years left on the agreement is hard to fund over seven years unless the franchisor grants a new term on transfer. The premises lease gets the same check. The lease term plus options should cover the loan term, and the lender will look at who holds the lease, the franchisor or the franchisee.

The franchisor has to approve every incoming franchisee, and that process runs separately from the lender's. Lenders usually ask for written franchisor approval as a condition of the loan. Under the Franchising Code of Conduct, the franchisor must give a prospective franchisee the disclosure document at least 14 days before the franchise agreement is signed. It sets out set up costs, ongoing fees, supply restrictions and contact details for current and former franchisees. Lenders expect buyers to have read it and to have had legal and accounting advice on it.

An existing franchise being resold has its own trading history. The lender can see two to three years of financials for that store, test the add-backs, compare the store against the system benchmarks and check that earnings cover the proposed repayments, commonly by 1.25 to 1.5 times. The price includes goodwill, and the lender will check that the multiple paid is in line with other resales in the system. A resale also triggers a transfer fee, franchisor training for the new owner and often a refurbishment obligation, all of which need to be in the funding table.

A new site has no history, so the lender relies on the system's benchmarks, the site selection work, the lease terms and the buyer's forecasts. Costs are mostly the franchise fee, fit-out, equipment, opening stock and working capital for the first months of trade. Lenders are commonly more cautious on the percentage for greenfield sites and pay close attention to working capital, because new stores often take several months to reach break even. The buyer's own industry or management experience carries more weight on a new site than on a resale.

Equipment such as ovens, coffee machines, refrigeration, vehicles and point of sale systems can be funded with asset finance secured against the equipment, commonly over three to five years. That keeps the main loan smaller. Fit-out is harder. Joinery, flooring, signage and shopfronts have almost no resale value once installed, so general equipment financiers limit how much of it they will fund. Accredited franchise programs are more accommodating, and fit-out is often rolled into the franchise loan. Refurbishments required by the franchisor midway through the term are commonly funded the same way.

If the system is not accredited with any lender, the application is assessed as an ordinary small business purchase. Most major banks will lend little or nothing against the business alone, and the loan is sized on the property security offered and the buyer's ability to service it. New and small franchise systems, and systems with a poor closure record, fall into this group. A property secured business acquisition loan is the usual path, often drawn against a home as described in the page on using home equity to buy a business.