Sources of Business funding for franchises

Retail Capital

International franchises are growing in Africa on the back of saturated western markets and consumers’ demand for branded products. The benefits of the model are proven – franchises provide local entrepreneurs with  ‘ready businesses’ that create jobs, while brands get the opportunity to enter new markets with partners who are familiar with the specific market.

Compared to other countries, franchising is huge in South Africa. The sector is worth an estimated US$36-billion and accounts for 12% of the GDP, according to Standard Bank. Many local and international franchises operate franchises and include food companies such as KFC, McDonalds, Nandos and Burger King, recruitment company Executives Online and fashion retailer Mango.

As the consumer market continues to grow in South Africa, so will start-up companies that are looking to buy franchises. The sector is projected to grow substantially in the next two years, according to franchise expert Gerrie van Biljon. He says smaller and cheaper franchise units are emerging in sectors that have been extensively franchised, as operators look for ways to cut costs.

Money for start-ups is getting harder to come by, with traditional lenders becoming increasingly picky. The higher success rate of franchises in relation to other types of businesses means they are likely to get finances. The rejection rate of franchise finance is definitely lower than that of independent stand-alone businesses, says Gerrie. Eric Parker of FranchisePlus and co-founder of Nandos agrees with Gerrie’s view, citing the low rate failure of franchise business (at just 5% compared to 80% for other businesses) as an advantage when it comes to sourcing financing.

The proven track record of franchising makes potential financiers like Retail Capital more inclined to accept funding application. Says Vernon de Wet, a business development executive at Retail Capital: “Franchise enterprises are less risky than stand-alone, non-franchised stores. Typically a franchisee is well screened before the franchisor will take him on, a seed capital has already been paid, and they receive support by the franchisor in terms of marketing, training and advertising.”

This does not mean that there are no hurdles or risks involved. Success in one market does not automatically guarantee success in another. International beverage distribution company, Royal Crown Cola International, has learnt that consumers in Africa want unique tastes that cater to local palates and culture besides the beverages with foreign flavours. South African food franchise Steers established eight successful outlets offering variations to accommodate tastes in Kenya even as Nandos and Stuttafords folded operations in the East African nation.

A sound business plan and thorough research on competition and market environment of your location, which shows not only a feasible but also a potentially profitable and innovative venture, is critical if you are seeking approval of your franchisee and funding application.

In the current market where credit is tight, businesses have to be innovative about the way they access and source funding. The finance market is starting to diversify but it is a slow process.

“The fact that we have four main banks who are conservative in their approach to business funding has resulted in a number of smaller entrepreneurial type housing funds being formed,” says Vernon.

Types of franchise finance

The Whichfranchise group in South Africa sets up a useful breakdown of franchise finance into two categories –initial financial obligations and on-going financial obligations.

Initial obligations- This consists of the mandatory upfront fee, which provides you with access to the franchisors brand, market structure and start-up support; the set-up    fee, which includes construction, equipment, stock and other necessities specific to your business type. The third component is working capital to pay your staff and yourself before you have a cash flow.

Ongoing obligations – This refers to the management service fees and an advertising market levy, which are both specific to the franchisor. Upkeep, weekly or monthly rent, salaries and stock would also fall into this category.

US-based franchise market analyst, Eddy Goldberg, suggests a different separation strategy that can assist in sourcing finance. He advises one to ‘separate your capital requirements into three or more parts: franchise fee, equipment, real estate, and other start-up costs. Lenders specialising in equipment loans or real estate may be more willing to provide funding than a single, general source’. This way, you can apply for more specific financial assistance. If you procure funding from one source it will make it easier to attain the other portion.

Sources of franchise finance

The first stop for start-ups is usually banks for loans. A recent survey carried out by Retail Capital shows that almost “60% of applicants cited lack of flexibility as the top frustration when obtaining a business loan from a bank, followed closely by the length of the application process and poor approval rate.”

Nevertheless, there are other financing options may suit small enterprises.

Franchisor-franchisee Options

Some franchisors offer financing to prospective franchisees, or have established agreements with lenders. If they have approved your application, this could act as a key advantage.

There may also be circumstances where franchisors will pair well-capitalised applicants with little experience with an experienced operator seeking financing.

It is advisable you research this option thoroughly when seeking out potential franchisors.

There have been many successful initiatives where franchisors have established a joint venture with the franchisee. This is an attractive option because other lenders have the approval of the franchisor as well as incentive to make it succeed.

Tandem franchising

Eric of FranchisingPlus established this system as a mentorship program and Black Economic Empowerment initiative. The franchisee purchases a small share in the franchise and manages the business under the mentorship of the franchisor or another experienced member in management. The accrued profit of the candidate will be used to buy shares in the franchise until he becomes the sole owner of the business.

Government programmes and incentives

The list of grants, development funds and incentives is extensive. Sources of grants include manufacturing investment program, sector specific assistance scheme, tourism support programme, co-operative incentive scheme, support programme for industrial innovation, capital projects feasibility programme and others. Grants are awarded based on specific criteria, and it is crucial you do extensive research to assess the credit record of the grant, and check that the criterion is suited to your initiative and vision.

There are many financial institutions or agencies established as independent or conciliatory agents to state institutions, which are focused specifically on assisting start up enterprises. They include the Small Enterprise Finance Agency and the

National Empowerment Fund (NEF). NEF approved R23-million for nine franchise outlets in Western Cape Province in 2012.

Advance cash option

This involves advancing a lump sum of the business’ future sales – so the business effectively funds its own growth. The franchisee returns the money by paying an agreed amount off their card transactions. Vernon of Retail Capital, which operates this funding model, says it allows a franchisee to continually make improvements to the store without the pressure of having to worry about raising business funding through traditional means.

Investors and venture capitalists

The advantage of finding an equity investor is that the funding does not have to be paid back. Shareholder dividends are usually paid once the cash flow allows it, which is an important advantage for start-ups that are willing to concede equity shares.

By Jess Richards, Frontier Market Network


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