Obtaining financing for a new, independent business is difficult in the current economy. Formatted franchises, and particularly resales, are more attractive because they bring a number of stabilizing forces that increase their chances for success. These forces include the franchisor’s training, screening process, administrative support, and well-developed business format. For resales, the additional incentive for lenders is the history of net income and cash flow available for evaluation. Thus, for obtaining financing, all franchises with good brand images have an advantage, increased further when the franchise is a resale. Consequently, in this article both of these points will be discussed.
Banks and third-party lenders are more prone to lend money for a franchise brand with a solid history based on a proven business plan. These plans include a management matrix that franchisees can utilize to avoid many of the mistakes inherent to most independent start-ups. Lenders understand that a successful franchise concept has been tested and provides for rapid expansion and historically low rates of loan default. For this reason, as early as 2001 business format franchising had over four times as many establishments, employed four times as many employees, and produced two-and-a-half times the payroll as that of product distribution franchising (companies that do not follow a set franchise matrix of management and marketing).*
*Dave Thomas and Michael Seid, Franchising for Dummies 101 (IDG Books Worldwide, Inc.)
Getting loans is even easier for buyers of pre-existing franchises, commonly called transfers or resales. In these cases, the lender does not have to base the lending risk on hazy projections and hopes for a particular location. Instead, financiers can analyze the re-sale’s three-year record of gross income and cash flows, in addition to the demographics and consumer traffic of that location. These are concrete data upon which lenders can base a solid decision.
Lenders can also evaluate the seller’s management style and general practices by combining these data with information provided by the franchisor. Most franchisors are eager to get buyers financed and should facilitate the process with whatever information is needed. This might include cash flow or sales figures and profits for other franchisees in the same region. If a franchise seller is failing, the franchisor might know and offer the reasons why a buyer of the re-sale would have a higher chance for profitability, if that were indeed the case.
When lenders analyze the data provided, they can also review the seller’s spending habits. Some franchisees run unnecessary, sometimes extravagant expenses through the business for vehicles, hotel costs, or even seasonal sports events. These expenses can be added back to historical net income to provide a better reading of potential cash flow and net profit for the buyer’s and lender’s consideration.
The big question is whether or not the resale is likely to earn a decent margin with “new blood” flowing through the franchise operation. If the answer is yes, and the buyer has a solid credit history, getting a loan for the transfer should be much easier than attempting a loan for a brand new franchise location.
On the macro level this is also good news. In 2010 the federal government allotted $30 billion dollars to the U.S. Treasury Department under the Small Business Lending Fund Act. This legislation allows the Treasury to loan many multiples of that in new credit through the Small Business Administration and through conventional lenders. Franchising as a business model has been highly resilient to economic downturns. In past recessions and post-recessionary times, franchise operations have grown by 6%, and even during the tech bubble of the early 2000’s, franchises grew by 5% (SBA; FTC).
Since lenders have new credit available, but are paying closer attention to lending results, this spells good opportunities for buyers of franchises, especially for buyers of resales and their attendant histories. With new opportunities available for lenders to lend, the most likely place they will look is at re-sales, because they simply outperform other financing risks with historically low default rates. There has never been a better time than the present to get financing that is if it is a franchise resale.