The Franchise Forum

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Financial considerations for franchise acquisitions

When financing a franchise acquisition, it's important to consider every option available to you. Will you utilize a bank loan or leverage personal capital?

Before you can answer that question, you'll need to understand which external factors determine your financing options.

"If you're a first-time franchisee and you're looking to acquire underperforming units, it's going to be hard to get a loan for financing," says Randy Jones, Head of Originations at ApplePie Capital. "On the other hand, if you're a large operating franchisee who has profitable units, some borrowing capability and a track record showing you can turn units around, you can likely get financing for underperforming units."

This is but the first of many considerations a franchisee must contemplate before he or she can make an informed financing decision.

Be strategic about your financing options
Financing underperforming units in order to turn them into successful stores has its pitfalls - but financing well-performing units has its own challenges.

As Randy says, "If it's a well-performing store, the challenge becomes that the cost of buying it is going to be higher than opening a new store because the cash flow multiple results in a higher purchasing price."

The cash flow multiple depends on two variables: the cost of capital and the rate at which a company's cash flow grows. If the cost of capital is high, the multiple will become lower. Similarly, the higher the rate of cash flow growth, the higher the multiple. It may be a good idea to analyze these variables separately, then together, to help you determine the best course of action.

"It's best to utilize bank funds and hold onto your cash if you're looking to purchase additional units."

"It's best to utilize bank funds and hold onto your cash if you're looking to purchase additional units down the road," says Randy. "The tricky part is, if you borrow too much money, you're not getting any benefit from the acquisition because it's all going to debt service."

You'll also need to take into consideration the monthly cost of the bank loan.

"It may be wise to not borrow too much and contribute some of your own cash, so the monthly payments are manageable," Randy notes.

SBA loans, 401(k) rollovers and personal collateral are also viable financing options, but each depends highly on your unique financial situation. Make sure to read about the risks involved with each before reaching a final decision.

Understand why lenders are taking on more risk now
If you follow the markets, you may have noticed that lenders are willing to accept more risk now than they have in recent memory.

In the years immediately following the market crash of 2008, lenders tightened their grip on capital loans. As the economy bounced back, they loosened up and become increasingly willing to lend to small businesses. However, lending markets are cyclical. What goes up must come down.

"I don't think we're heading for a crash like in 2008, but specific industries may see a course correction," says Randy.

Franchisees should look at ticket prices and sales numbers to help them determine the best path forward. For instance, the quick-service food industry has seen flagging sales and higher ticket prices over the past two years, and consumers can only bear so much of the burden. Navigating the shifting sands of the marketplace is difficult, and franchisees need to be prepared to do their homework.

To control the cost of acquisition and enter the market on a firm footing, newer franchisees should be wary about expanding too fast.

"When you're adding stores quickly, you run the risk of ignoring the stores that are doing well," cautions Randy, "If you add a few units that need some attention, you still need to pay attention to those units that got you to where you are today." 

Look at the acquisition from every angle and analyze the math before you decide which financing strategy is right for you.

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