Minor details. You have made the commitment to purchase a new or existing franchise in Canada and must attend now to that final detail – you need to figure out how financing a franchise works in Canada! Franchise financing is a specialized industry in Canada, and your ability to investigate and source and finalize the proper franchise financing will of course be one of the reasons for your success as a Canadian entrepreneur operating within your franchise segment.
Whether you are Canada’s largest corporation, or the owner of a Canadian franchise its all about debt and equity. Simply put it’s the balance between how much you will borrow and how much of your own funds will go into the business. The franchise finance landscape in Canada is littered with many cases of business owners who did not match up, so to speak, the right amount of debt and equity.
There is an interesting point we can make about whether there is in fact a perfect formula or combination to the optimal amount of borrowing or personal funds that go into your new business. It’s a financial concept called R O I – which stands for return on investment. Let’s use a simple example to illustrate our point. If a franchise cost you one hundred dollars, and you paid all cash for it with personal funds and your profit in the first year was one hundred dollars then your overall return on investment is not great, as you can see. . However, if you borrowed 90 dollars, and put in ten dollars of your own money and your profit was that same one hundred dollars then you have generated a ten fold return on investment.
So that’s a good thing , right – well not necessarily, because your business has a lot more debt than ownership equity, as a result you are deemed to be very leveraged – if sales go down or profits aren’t achievable the owner has , in the creditors eyes, very little stake in the business .
Enough though of some of our textbook financial analysis we have just illustrated – what happens in the real world of franchise financing is what our clients want to know. The reality is that over the past several years, due in part to the current poor financial environment, owners have been obliged by lenders to put more and more equity into a new franchise. Although in some cases a 10% down scenario is possible, the reality is that number approaches 30-50% in most situations.
So a large part of the planning around financing a franchise should involve a couple things; your business plan or cash flow model should understand what amount of debt the business can handle, and in particular you should also understand the working capital needs of the business. It is not recommended to only focus on buying the business, as sooner or later you will have working capital or growth needs, so take that into account also.
Your financial planning around your financing should take into account the franchisors experience in the financial needs of the business – in a perfect world it is important to try and talk to some existing franchisees as to how their overall financing strategy works.
In Canada the majority of franchises are financed by a special federal government program called the BIL, or in some cases aka CSBF loan program. You need to ensure you meet the general criteria of this program. In our opinion no one financing method can really accommodate all your franchise financing needs, so we advise clients to consider a number of approaches including the above noted program, equipment financing where relevant, and in some cases a working capital term loan. Naturally all of this financing is under pinned with your own personal equity contribution into the business, which we discussed earlier.
So what is our take away on financing a franchise in Canada – there are a couple as we noted. Plan the financing of your franchise early on in the process and integrate it into your overall decision to purchase the business. Calculate what works out best for you relative to the ROI equation – what do you need to borrow, and what funds are available to put in yourself.
Speak to a trusted , experienced and credible business financing advisor in franchise financing to ensure you understand your financing options and that they can be presented to the lender in the best possible light . That’s a success Canadian franchise financing strategy