How a Franchise Agreement and a Franchise Disclosure Document differ
There are two documents that are of vital importance...
Franchising offers the opportunity to buy into an existing, successful business to make it your own, be your own boss, set your own hours and earn a salary commensurate with the effort that you put in. Before you can start making money, you will need to outlay some money. There are several ways in which you can do this, and the safest options are explained below.
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Self Finance
This is where you use personal funds such as savings or an inheritance to fund your franchising dreams. If you have enough funds to buy into your chosen franchise outright, this is a great way of getting your new business up and running as quickly as possible, and you will not need to repay any loans or finance agreements. This means that all the money that you earn will be yours. It is wise to remember, however, that if you invest all of your savings and your franchise isn't successful, you will not be able to get your money back.
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Franchisor Financing
Many franchises provide financial assistance to new entrants in order to help them to get up and running as quickly as possible. They typically set up loans or finance plans to help new franchisees fund their startup costs, such as equipment, signs and fixtures. Repayments are typically based on interest from sales, fixed monthly payments after a certain period, or repaid in one bulk payment after a predetermined time frame. Franchisor financing puts some of the risk onto the franchise, so by offering you the money to get started, it demonstrates their confidence that you will be successful and is a reasonably safe way of borrowing money to start up your business.
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Bank Loan
The typical way of funding a new business is via a bank loan. This requires you to convince the bank that your business plan is sound and that they will get their money back in accordance with their lending criteria. In addition to a solid business plan, the bank will require that your personal credit is in good standing and that your personal paperwork, such as tax returns and financial statements, demonstrate your ability to repay the loan. Many senior banks do have specific franchise financing programs. In most cases, senior bank loans will require collateral to secure the loan.
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Government-backed Loan
The Canada Small Business Financing Program offers potential franchisees the opportunity to get a bank loan whereby they guarantee a significant portion of it should you default on your repayments. It can be a lengthy application process, and your business plan and personal finances will need to be in order before you can apply.
The Business Development Bank of Canada (BDC Bank) is another government institution that offers financing programs for business and/or franchise acquisitions. In many cases, a BDC bank loan will emphasize a strong business plan and cash flow projections over collateral to secure the loan.
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Other Sources
There are other ways in which a potential franchisee can obtain the money they need to get started, such as borrowing from friends or family or approaching an alternative financing company, but these options are best avoided unless there is no other option.
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Cash Flow Projections
When an individual is considering buying into a franchise, their goal is usually to make a living from operating the business, and doing so with confidence requires a positive cash flow projection to be developed. This is essential if you will need a bank loan to fund the startup. However, you may find that franchisors and other franchisees aren't able to provide you with solid answers about their expenses and earnings. There are many reasons this may be the case, including their location, levels of local competition, effort expended, cost of premises, staff salaries and even just a desire to not feed you misleading information.
What you can do instead is find as many facts as possible and use these to generate your own cash flow projections to determine whether the business looks like it may be profitable based on your location, experience, time, resources and abilities.
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Expenses
Knowing what you need to spend is the first step. Make a comprehensive list of all of the expenses that you will need to cover, both as one-off fees and ongoing monthly or annual payments, in order to be a franchisee of your chosen business. Tailor this appropriately to your own situation, taking into account local rent, taxes, salaries and other items of consideration.
Develop a best-case and worst-case cost estimate, noting that the reality is likely to be somewhere in between. Ask the franchisor and any other franchisees who are willing to help you to review your list of expenses and suggest any that you might have missed.
They should include the purchase of stock and marketing materials, any particular tools or software that you will need, your franchise fee, any accounting or legal costs, and the monthly royalty payments, taking care to note whether they are set as a fixed monthly fee or as a percentage of sales or profits.
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Income
Income is somewhat harder to estimate, but you can create a best- and worst-case scenario based on the projections of your franchisor, the retail markup applied by other franchisees, and estimating your likely sales by assessing the performance of competitors in your local area. To maximize profits, investigate whether any government subsidies exist for your chosen type of business in your area. If needed, seek professional advice from a local business accountant, who can help to guide your forecast.
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Summary
By creating your own cash flow projections, you will be able to develop a comprehensive understanding of the likelihood of your success, which will help you to determine whether the franchise that you are considering is indeed right for you.
