It’s no easy task to get a bank to buy into a business concept. They are notorious for having strict requirements and being cautious when deciding who they will do business with. A franchisee looking at investing a significant amount of time and money into a new franchise needs to do thorough research before signing any agreements. By applying the same thinking as banks, you should be able to determine whether the franchise you are interested in is a good investment.
Here’s how four of South Africa’s biggest names in banking evaluate franchises.
According to Morné Cronje, sector head: Franchising, Absa looks at the support structure provided by the franchisor. The bank looks at whether or not the franchisor has a programme in place to assist the franchisee over any stumbling blocks that may arise. “Where the franchisor is more involved, it is easier to assist,” he says. Cronje explains that Absa doesn’t grade franchisors, and views emerging franchisors very differently from those with no track record. He says the franchising division will assist in building a plan for a new franchisor to enter the market.
The bank will need to look at their business plan to determine the risk involved. Absa employs regional franchise specialists who will compile a report based on a full analysis of the franchisor, this is then presented to the bank’s shareholders. Some of the aspects analysed include the financial background, where the franchise first started, how many closures they have had, their profits and how many new stores they plan to open.
Riaan Fouche, head of FNB Franchising, says FNB has a franchise rating model that it uses. A franchisor earns points for certain aspects of the business and is then given a rating of A to D. The rating is used to determine the risk posed by that franchise and will influence the pricing. While FNB does not publish its rating system, Fouche highlights five important points to look at when evaluating the risk posed by a franchise.
Background of the business and its directors. This includes looking at their past experience and qualifications.
- Financial stability of the franchise.
A franchise cannot support a franchisee if it is not financially stable. It is also important to look at the franchise’s main source of income – is it from company-owned outlets, rebates from suppliers or royalties from franchisees?
- Franchise agreement, disclosure document and the operations and procedures manual.
- Performance of existing franchisees.
- Expansion plans of the franchise.
While an ‘A-grade’ franchise is generally considered to be lower risk, Fouche explains that FNB also has an incubator category which recognises franchises with great potential. In this case the bank will fund some franchisees and see how they perform. The bank also assists a franchisor in the ‘B’ category to improve and move up to an ‘A’ rating.
Mark Rose, head of new business development, Nedbank Business Banking, says Nedbank doesn’t work with categories. Instead, the different brands are grouped into segments – retail, fuel and the food sector.
Nedbank goes through a full accreditation process on a brand, taking into consideration the sector it operates in. He calls this a “fit for purpose approach.” Rose explains that Nedbank targets the brands that have a good track record, strong brand presence and have shown that there are opportunities for growth. A full accreditation is then done on the brand, which involves sitting with the franchisor and doing an in-depth analysis. Some of the aspects that are looked at include the franchise system, how many stores there are, how many closures there have been, and the reason for the closures, the franchisor’s strategy for distressed stores, what support is given, how the site selection works for a new store and how a franchisor recruits and selects franchisees.
Standard Bank uses an ABC, 123 system in its franchising division, explains Thabiso Ramasike, head of franchising. When it comes to franchisors, he explains that not all brands are at the same level or have the same profile. The rating system helps the bank understand its clients requirements much better, he adds.
A ‘C’ franchisor is usually one that has been franchised for five years or less, hasn’t become a member of FASA and is still finding its feet while it has picked up an opportunity to fill a gap in the market. The entry barriers tend to be minimal, so C franchisors have lower costs and offer more flexibility in terms of accrediting franchisees. These brands are usually growing quite rapidly, but haven’t really mastered the art of providing training and support to a franchisee. There are usually a few failures.
Ramasike says a ‘B’ franchisor has usually been operating as a franchise for five to ten years and has systems like IT, management support and training in place. They will usually have developed tools to assist with site location and are still in the growth space, even looking beyond South Africa’s borders. They are fully established FASA members and have established relationships with banks. In South Africa, Ramasike says this category of franchisor is quite dominant.
An ‘A’ franchisor has been operating for over ten years, is usually listed on the JSE and is often multinational. These franchisors have limited failures, in most cases there are no failures. They are passionate about their brand and have an influx of franchisees so they can afford to cherry pick them to ensure they get the “best of the best.” The training offered is intensive and the support structure immense. According to Ramasike there will usually be a team responsible for the different components. He explains that there are only a few ‘A’ franchisors in the market, but they have a huge footprint.
There is also a ‘D’ category, adds Ramasike.These are typically franchisors Standard Bank doesn’t want to do business with, usually because they have been dishonest or unscrupulous. They have sometimes been expelled by FASA, have a weak franchising system, numerous closures and only train franchisees for around two days.
What is your category?
Standard Bank uses a 1-2-3 rating system for franchisees based on their experience and commitment to franchising.
1. A multiple store owner is placed in this category. These are people who are in the business of franchising. They have their own companies with subsidiaries, which are the various outlets they own. They should own a minimum of three to five to qualify for this category of franchisee. They are considered corporate entities on their own, and are often multigenerational franchisees. They are taken very seriously by the franchisor and usually sit on councils, executive committees and assist in driving strategy. Larger franchisors prefer to have one franchisee owning three outlets than four franchisees each owning one outlet as it reduces the need to coach new franchisees.
2. Franchisees in this category usually own two to three stores and work on franchising full-time. They are in a totally different space to the other categories but are starting to see the benefits of franchising. They begin building a strong relationship with the franchisor and achieve a certain level of success.
3. This is a franchisee who owns one store, is new to franchising, and usually runs the franchise on a part-time basis.
Types Of Funding Available For Franchisees
If you’re interested in investing in a franchise, there are a number of funding routes available to you.
In South Africa, a franchise is considered a separate, specialised field of business and from a financing perspective is viewed differently to an existing business. It’s typically easier to get funding for a franchise as franchises have a proven product and they vet potential franchisees and offer support to new business owners. This support can include extensive training on running the franchise, branding and marketing, operational policies and procedures and a highly-tuned supplier network.
The reputation of the franchise will, to a large extent, dictate which finance options you choose and how easy it will be to raise the required funds.
It’s important to understand the cost of purchasing the business and the expected operating costs to work out how much finance you’ll need until the business starts to generate profits. Be clear about the upfront costs, including access to the brand, the market structure, start-up support and the set-up fee, which usually includes construction, equipment, stock and other necessary resources.
Consider the operating costs, which must include management service fees and franchise marketing and advertising levies. The franchisor will advise you on the time it should take for the franchise to start generating profits. Upfront costs plus operating costs are the total amount of finance required to purchase, set up and run the franchise.
What’s available for prospective franchisees?
Many of the large franchisors have their own funding mechanisms. These can range from their own established finance arm to funding assistance through partnerships with external lenders. Franchisors seldom fund 100% of the purchase costs; the amount of funding varies according to the size and reputation of the franchise and usually ranges from 25% to 75% of the costs.
Once a franchisor approves you as a franchisee, your chances of being approved for funding are significantly stronger. Some franchisors go a step further and suggest a business partnership with another potential franchisee who has good financial resources but less experience. Pairing experience with finance can be a useful option, but needs to be explored properly as it is a long-term partnership that must work for both parties.
Tandem Funding and Specialised Franchise Funders
South Africa’s B-BBEE legislation has led to a new option for franchise funding. It’s a particularly innovative way of quickly upskilling inexperienced potential franchisees. The franchisor funds the new franchise and retains ownership of the majority of shares in the business.
The franchisee initially purchases a small number of shares and is then mentored by the franchisor to set up and run the franchise. Profits are used to buy more shares until the franchisee has purchased all the franchise’s shares.
Specialist franchise funders are also a useful option. They typically consider a wider variety of franchises than banks and have in-depth knowledge of the industry. However, like other funders, their primary concern is to be sure that the loan will be repaid within the required period.
Franchise Funding from Banks
All of the large banks have specialised franchise funding departments. Their approval rate for funding franchises is generally higher than for independent businesses.
Banks will expect you to provide a sizable contribution toward the purchase of the franchise and funding is dependent on proof that the business will be able to repay the loan.
Other factors they consider are the location of the business and its proximity to competitors and catchment markets, your level of business experience, your credit record and the amount and type of support offered by the franchisor. The higher the level of support, the less the risk to the funder of the business under-performing.
If the franchisor is willing to enter into a joint venture with you to partially fund the purchase, the bank will consider this positively as it means the franchisor has a vested interest in helping you to succeed.
Government Franchise Funding
All of the government funding agencies offer franchise funding primarily to encourage black entrepreneurs to enter into the franchise business. For example, the National Empowerment Fund considers funding based on a minimum of 50,1% black shareholding, provided that the black shareholders are actively involved in managing the business.
They prefer to fund well-established franchises, fund up to R10 million and expect to exit within seven years, so you’ll need detailed projections to show that the loan can be repaid within that period. Ithala Bank considers funding for KZN-based approved franchisees who do not have collateral.
What funders expect from you
Lenders expect you to provide detailed information that will enable them to assess the risks of lending to the franchise. This means they require a detailed business plan, comprehensive and well- substantiated financial projections and full details of the franchise, its agreement terms and the levels of support they will provide. They will also need details of start-up costs; for example, construction, set-up costs, equipment and other resources required to establish the franchise.
Franchise lenders expect you to have concluded discussions with the franchisor and want to know that you have been approved. This pre-approval means that there is less risk to them. You’ll also be expected to provide feasibility studies from the franchisor.
The purchase of a franchise requires an injection of your own cash and if you are borrowing money, you’ll probably need to provide collateral. You’ll need a statement of personal assets and liabilities for each of the directors, a good credit record and detailed CVs of the owners to show the required business experience.
The more well-known the franchise, the higher the price, so do your homework before applying for finance. Understand the full cost of starting and running the business to make sure you aren’t in for future surprises. In particular, work out your current liquidity status.
Keep a small contingency fund available for unexpected expenses, so don’t invest all available capital in the venture.
Shop around. Compare finance institutions’ offerings to make sure you get the best deal. In the case of less expensive franchises, consider working with a couple of lenders; for example, an asset funder to fund equipment needs and a franchise funder for the start-up and working capital costs.
Factors To Consider Before Signing Up As A Franchisee
Franchising is a brilliant way to get into business with not many entrepreneurial skills as it comes with a roadmap to follow for success.
You’ve been considering entrepreneurship for a while, and now that you’ve finally raised some money and been approved for a loan, you’re ready to quit your 9-5 job to run your own business. You may even already have your eye on a particular franchise, but while franchising is considered an easier and more low risk way to get into business, are you suited to being a franchisee?
“The question is not ‘is franchising right for you’, but rather, are you right for franchising? Because if you don’t have the right attitude and skill set, it can be a very expensive mistake,” says small business expert and author Steve Strauss.
Franchising may seem like an easy way into entrepreneurship, but along with an established name and proven systems, come rules, regulations and little room for creativity. If you’re not ready to become a franchisee, but want to go into business for yourself, you may find yourself struggling to operate within the system’s blueprint.
Ask yourself these three questions before proceeding with the process of franchising:
1. Will you be able to follow the directions of the franchisor?
You’re buying into an existing and proven concept so it’s safe to assume that the franchisor knows best, and so you have to be open to learning and following guidelines for business success. If, for example, you have experience in advertising and think you have an improved technique of marketing the franchise, you may want to change the advertising material provided by the franchisor – don’t.
“Being a franchisee means following the directions of the franchisor, even when you think you know a better way,” advise experts from strategic and tactical advisory firm MSA Worldwide.
“In addition to initial training, you need to be prepared to accept coaching and advice from the franchisor on how you operate or market your location.”
2. Do you have the need to experiment?
Lou Groen may have had success in launching a new menu item that McDonald’s approved of in 1962, but not all franchisees are that lucky. Stick to the plan and limit deviations to the menu or anything that involves the customer experience.
If the franchisor’s concept doesn’t involve deliveries, offering them to your customers may cause issues for others within the franchise system. “If it’s not part of the franchisor’s concept, you’re deviating from the concept and therefore, no longer running your store as a franchise,” according to MSA. Franchising arguably limits innovation opportunities, so if you’re prone to implementing creative ideas and evolving business offerings based on said ideas, rather start your own independent business.
3. Are you a team player?
These first two questions you address should already lead to the realisation that everything you do affects everyone in the franchise chain. One bad experience at your establishment and suddenly, all the stores are affected by bad press or unsavoury social media attention.
“Other franchisees are relying upon you to offer to the consumer a consistent level of service, product quality, and brand message. You are going to have to work with others in the system in making decisions,” advise experts.
Remember that as part of a chain of other business owners, you may have to accept that majority rules when it comes to decisions where franchises do have a say.
3 Ways You Can Innovate And Improve As A Franchisee
Although your role as a franchisee isn’t really to innovate, there’s room for creativity if you go about it the right way.
When you signed on the dotted line after reading and agreeing with the franchise agreement, you knew that you were buying into a proven system where everything has already been thought out for you, and all you have to do is follow the formula for success.
But you’re a franchisee longing to put your own imprint on your business, and it may be frustrating to feel boxed in by a formula, while you’re bursting with new ideas.
“Franchising, by its nature, discourages innovation on the part of franchisees, who are required by their franchisors to follow very specific policies and procedures on exactly what they will sell, how they will make or deliver it,” notes Randy Myers, contributing editor for CFO and Corporate Board Member magazines.
This doesn’t mean your ideas will never see the light of day though. But before you approach your franchisor with your brilliant insight, consider the following steps that may well lead you down an innovative path:
1. Get the basics right first
Franchisors know that customers like consistency as it makes them comfortable and trust every location of their franchise they choose to visit. But, even the strictest franchisors get hungry for new ideas. It’s the timing that’s vital for your idea to even be considered.
“Most good systems don’t want new franchisees to even think about innovations until they learn the existing system inside out and prove that they can execute it like a star,” said Jeff Elgin, CEO of FranChoice, a network of franchise referral consultants. “At that point, they have become successful, their base is secure, and they have earned the right to consider innovations.”
It’s wise to ensure you’ve learned your franchisor’s existing business model before you suggest any improvements.
2. Do your homework
So, you’re doing well and you’re sure your idea will be welcomed as a crucial innovation to the franchise system – but research your proposal, suggests Kim Stevens, VP of Regional Development and Director of Franchise Awarding at Woodhouse Day Spas. “Especially if you’re suggesting something that would impact all franchisees, create a business plan before approaching your franchisor,’ she says.
It’s also good to have another look at the franchisor’s policy for accepting new ideas to ensure you’re prepared for tough questions before you propose your idea.
3. Speak to the right people
Elgin recommends you first identify the person at the franchisor’s head office who’s responsible for receiving new ideas. “Many of the ideas a franchisee comes up with will already have been proposed by another franchisee,” notes Elgin.
To avoid wasting your time, no matter how great you think the idea is, present it as early as possible before spending anything developing the idea.
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