Buying a franchise is a huge decision that requires a lot of thought. Before you buy a franchise, you need to be sure how much you can afford to spend. This article will take you through the key steps to evaluate your financial position before taking advantage of potential franchise opportunities.
Consider Your Assets
The first step to evaluating your financial assets is to work out your personal net worth. This is important to understand what franchise businesses are realistically within your budget. You can determine your net worth by compiling a statement of your personal finances. This involves looking at all your assets and deducting any debt that you have.
The table below shows the financial assets of potential franchisee, Sam.
| Asset | Value |
| House | $800,000 |
| Car | $30,000 |
| Insurance policy | $20,000 |
| Savings | $40,000 |
| Total Assets | $890,000 |
| Liabilities | |
| Mortgage | $400,000 |
| Equity | $490,000 |
When Sam seeks to borrow against his equity, the banks will assess his assets more conservatively. For example, the bank may allow a potential franchisee to re-finance only up to 70% of the house’s value. As such, having a house with a current value of $800,000, the bank might only lend $560,000, being 70%. Deducting the home’s mortgage from this leaves only $160,000.
If the bank will consider the car, insurance policy and savings into consideration, Sam has a total amount of personal funds available for purchasing a franchise worth $250,000.
Look at Business Loans
Once you have evaluated your assets, you need to consider your access to business loans. This will be repaid from the cash flow of the business. Most franchises will have arrangements with one or more major banks and prefer you take out a business loan with them.
The amount each bank will loan you will differ on a number of factors, including:
- your financial position;
- the bank’s lending policies;
- the industry you will operate in;
- the type of franchise system; and
- the current economic climate.
You must not overextend yourself when buying any business, including a franchise. A good rule to follow is to have a minimum of 50% equity. This is a lot more sustainable and will ensure your business can withstand difficult financial times.
As a prospective franchisee, you also need to understand working capital. This refers to the money needed for daily business operations. You may need this money to buy stock or supplies or pay utility bills. It will likely take some time to generate revenue, so you must build the costs of working capital into your budget from the start.
Continue reading this article below the formUnderstand How Much You Need
The next thing to assess is how much money you need for your personal expenses. You should be as realistic as possible and consider expenses such as:
- Food;
- Utilities;
- Clothing;
- Entertainment; and
- Discretionary spending.
If you have a partner that you can rely on, you should work that into your assessment as well.
Following on from the above example, below are Sam’s expected personal costs.
| Item | Cost |
| Living costs | $25,000 |
| Mortgage costs | $36,000 |
| Income required (pre-tax) | $61,000 |
The above means that Sam would need to generate a gross income of $61,000 per annum to cover their own expenses.
Reflect On What You Want
Buying a franchise means more than just buying a business. You will be investing a significant amount of time into the business. Consequently, you should expect a return on the time you invest as well. This amount should cover more than just the salary you require to meet your needs. This amount should also reflect the time and risks, both financial and legal, that are involved in purchasing a franchise.
This makes it important to consider what you want to get out of buying a franchise. For example, are you content with taking low returns and just want to be your own boss? Or is it the case that you want to build an asset worth selling at the end of your franchise term? By assessing your goals, you can better understand the rate of return you require.
Look to the Numbers
Based on Sam’s figures above, we know that they are able to spend a maximum of $250,000 on a business. Sam also needs this business to provide a minimum gross income of $61,000 to cover their expenses.
Sam should therefore analyse the potential of the franchise they are looking to invest in to try to project their earnings. For example, if you are Sam, you should examine the franchise’s success in different locations. Further, you should request information on the costs of running the business and the business’s earnings. However, this information should just be used as a starting point, and these numbers should not be relied upon.
This guide will walk you through the due diligence process when purchasing a NZ business.
Key Takeaways
If you are looking to buy a franchise but are struggling to determine what you can afford, the first steps you should take include:
- considering your assets;
- looking at business loans;
- understand how much you need; and
- reflect on what you want.
If you need help deciding if you can afford to buy a franchise, contact our experienced franchise lawyers as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0800 005 570 or visit our membership page.
Frequently Asked Questions
When evaluating your financial position to determine how much you can afford, you must first consider all your assets and liabilities to calculate your net worth. Then, you need to understand business loans and how much a bank would realistically lend you. Next, you must understand how much you need to meet your daily living expenses. Finally, you should compare these figures to your longer-term goals.
There are a number of reasons someone might choose to buy a franchise instead of starting an entirely new business from scratch. In a franchise, the franchisor provides a developed way of doing business and ongoing guidance, support and systems.
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