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Start-up franchisors usually find it difficult or even impossible to receive franchise finance for their franchise growth plans from traditional financiers without providing adequate real estate security.
Franchise finance cashflow funding options for aspiring franchisors are rare, whereas cashflow lending is often made available by banks to franchisees of established franchise business networks, where the franchise brand and the franchise concept are considered to have proven themselves in the market. (Information on franchise finance for franchisees is available in the franchisee section of our website).
For a franchisor however, once a franchise business has exhausted its ability to borrow against its own real estate, or that of its shareholders or directors, franchise finance for further growth is limited to cash that can be raised from other sources.
These franchise finance options include selling equity in the franchise business through a public or private offering, or franchising existing stores or operations, the effect of which is to realise their cash value but retain these under corporate control.
Accessing external capital, often referred to as the capital constraints theory, is the reason many businesses turn to franchising.
In other words, when traditional funding options are not available, a business may consider franchising as a way of accessing external capital to continue to grow.
This may start with the sale of existing company-owned stores or territories, and progress to the sale of new franchise locations (often referred to as greenfield sites).
If there are no remaining company-owned outlets or other franchise business operations to generate income, a franchisor is likely to rely on the sale of new franchises (rather than royalties) to reach break-even until the franchise business has reached enough franchisees for the total royalties to exceed the franchisor’s operating costs in running the franchise business.
Selling franchises to maintain profits and generate franchise finance is a short-term focus that does not augur well for long-term franchise business success for either the franchisor or the franchisee.
Such an outlook compromises franchisee and site selection criteria, both of which can lead to unsatisfactory outcomes for the franchisee (through the under-performance of their franchise business investment, and potentially, business failure) and the franchisor (through store closures, franchisee dissatisfaction with their investment, potential litigation, etc).
However, once a franchise business has reached its critical break-even number of franchisees and achieved a level of maturity in its franchise operations where it can survive on franchise royalties alone, it may be assessed by one or more of the major banks for special franchise finance lending packages for new franchisees.
Such packages may lend up to 70 percent of the purchase price of a franchise business outlet without real estate security, but instead rely on the proven cashflows of the franchise business model based on the performance and success of other franchisees in the group.
Similarly, once a franchise business has evolved to the point where such facilities can be made available to its franchisees, franchisors may also find their recurrent cashflows from franchise royalties are able to be used as security to fund further growth (for the establishment of additional company-owned stores for example).
In the evolution of a franchise business, franchise finance will initially be dependent on the provision of real estate security, and as the business grows and delivers sustainable cashflows for both the franchisee and franchisor, real estate security becomes less important than predictable franchise business performance.