Understanding ‘Net Worth’ and Unencumbered Capital’

Before you start your search for a franchise you will need to calculate your net worth and unencumbered capital. Many advertisements for franchise opportunities state that you will need a minimum level of unencumbered capital to meet the franchisor’s financial criteria. Your investment in a business will come from two sources: first loans against assets; and second, from your unencumbered capital or liquid assets from which you can obtain cash in order to invest in a business.

In order to calculate the level of your unencumbered capital you have to determine your net worth.

“Unencumbered capital" is a term used to describe your liquid assets, or assets which can be readily liquidated or sold for investment purposes. These are assets such as cash in the bank, perhaps loans that you have made to others which are easily collectible, stocks and bonds, which you can readily sell on the stock market and RRSPs for that matter. These are quite different from assets such as real estate which would not normally be sold, but which can be used for collateral. Different people may have the same total net worth, but assets can be distributed differently among liquid assets and equity, thereby making it easier for one person to finance a business than another.

Essentially, your Personal Financial Statement appears very much in the same format as that of a company. You have assets on the one hand and liabilities on the other. Your assets are all the things that you own. They are your cash on hand (e.g. in the bank), your life insurance surrender value, vehicles, and the value of your home, rental properties, and your RRSP’s etc.

On the other hand, your liabilities fall into two categories: Your liabilities are monies you owe to other people including banks, mortgage companies, credit cards, taxes and so on. So, if you take all the things that you own (your assets) and subtract all the money you owe to third parties (your liabilities), you are left with your net worth (e.g., if your sole possession is your home which is valued at $400,000, and you have a mortgage of $200,000, your net worth would be $200,000.

From the point of view of calculating your net worth for the purposes of obtaining bank, it must be understood that a bank is not interested in smaller items that you own, such as golf clubs, nor does the bank (or in some cases the franchisor) necessarily want you to cash in your RRSPs. Banks look at large assets, which are those that can be sold realistically in the event of a need to pay off the loan. So, the most important of these is typically your home. If you were to own shares in a publicly traded company, which is recognized by the bank as a stable venture, then these shares may also form some additional security or collateral for a loan.

Although a bank may be prepared to lend you sufficient monies against your home, given that there is sufficient equity, and you are able to liquefy some of your other assets to raise cash for your investment, you should also pay close attention to the extent of your liabilities. By borrowing additional funds and by liquefying your assets and investing them in a business, you may be placing yourself at undue risk, given that you may already have excessive liabilities for other reasons. To put it simply, if you already owe too much money and have limited cash reserves to use with further borrowings against your home to start a business, you can quickly get yourself into financial difficulties, even if the business is otherwise a good opportunity.

Learn more about franchise business opportunities in Canada at Be The Boss.