The number one reason for the failure of franchisors is under-capitalisation. If you’re thinking about franchising, it’s important that you have enough capital to launch and enough capital to sustain the operation until recurring royalties can cover your overhead.
Many franchisors wrongly assume that the amount they collect from selling franchises in initial franchise fees will cover overheads. But often the franchise fee revenue does not fund the necessary infrastructure, leaving the emerging franchisor scrambling. If you’re not sitting on a at least R2 million, you may run out of cash.
When launching my healthcare staffing franchise in 2005, we estimated we needed to invest R3 million. I contributed R1 million of our own money and accessed R2 million in debt financing. We were about 18 months in when the cash began to get painfully tight.
We had overspent on unnecessary or ill-advised hiring: at least R800 000 on legal and public relations firms; R400 000 for salaried employees to do work that contracted consultants could have done, particularly franchise training; and between R400 000 and R600 000 for outside help in the first year to handle franchise sales when that role really belonged to my husband or me. We actually needed R5 million.
Add up what we overspent on though, and you see that our initial estimate of R3 million would have been adequate if we had known then what we know now. While you might avoid similar pitfalls, you should still plan on R800 000 in additional cash reserves, over and above what your financial model shows you need, for unexpected expenses. Once you’ve figured out a realistic estimate for your opportunity, the next part is pursuing the funds. Here’s a look at the most common sources.
1. Banks. The capital markets have gotten tighter, but there is still money available. Banks review lots of requests, and they are going to be more inclined to loan to those who make their job easier by anticipating their concerns.
In our first business plan for franchising, we intended to sell ten franchises in the first year, another 25 in the second year, 40 in the third year, and about 50 each year in the fourth and fifth years. Naturally, the bank questioned how we would sell ten franchises in a year without any experience. But we had thoroughly researched our competitors and were prepared to convince the bank that we could meet our goal.
These days, you might need to pitch to multiple banks before finding a lender. You will need great market research on your industry and your performance compared with peers. You must exert strong confidence in your abilities to achieve your business-plan goals and to repay the loan. And you will need to have skin in the game. Expect to give a personal guarantee for the loan.
So be prepared before you meet with the bank. Make sure your package includes the following: a full business plan; financial statements for the first five years, including a statement of cash flow; and the competitive analysis on your industry to show that your assumptions for unit sales by year, royalty revenue per year and per unit, and earnings as a percentage of revenue are within the ranges of what has occurred historically in the industry.
2. Government programmes. I scoured all the possible government programmes, concentrating on ones that were available to me and sure enough, I found one that suited me. You’ll be amazed by the number of resources that are out there, but remember, government programmes have specific mandates, so choose the ones that suit what you have to offer.
3. Friends and family. Remember how I underestimated the money we needed by R2 million? That was a hard moment. We had to access more capital and really build, or entrench and stall growth. At that point, we had 12 franchisees who had signed up because of their belief in our vision. So we tabled our pride and asked my husband’s parents, my parents and extended family for a loan.
They agreed to help us. We structured the one-year loan with 14% interest (to match their returns in the market, since they had to pull out the money to loan to us). We were able to pay it back in 11 months. We will always be grateful that they stood by us. Receiving financial help from family members is humbling and is something that stays with you, grounds you, and drives you to never have to repeat the experience.