Franchises are available at all investment levels from a few hundred pounds to several million. In many cases, funding a franchise means taking on some form of bank borrowings. The December issue of Elite Franchise Magazine looks at obtaining finance for a franchise business and the different types of security that the bank is likely to ask for.
Finance and Legals
Unless you’ve won the lottery, had a large inheritance, or buy a low-investment business, buying a franchise will almost certainly involve securing bank funding. This month’s article looks at the legal side of obtaining finance and offers some practical tips for anyone about to apply for a bank loan.
As a general rule, banks like lending to potential franchisees because the risk of the business failing and therefore, the risk of the bank not getting repaid, is lower than for an independent start up. Having said this, success of any franchise is not guaranteed and banks wont hand out wads of cash without asking for some security.
Typically, the bank will ask for a personal guarantee from the key people in the business. This will always be in the bank’s standard form with no room for negotiation or amendment of the terms. Key clauses to look out for include:
- Is the guarantee limited in amount or unlimited? Even if guarantee is limited to a specified amount, the costs and expenses that the bank can charge in relation to enforcement will be unlimited. This means that if the guarantee is limited to say £10,000, the actual amount that you are potentially on the hook for will be £10,000 plus costs and interest.
- The guarantee will be a continuing security. This means that once given, it will remain in place indefinitely until such time as the bank releases it. As soon as the loan has been repaid, or if you are no longer involved in the business, make sure you contact the bank and get written confirmation that the guarantee has been released.
- If there is more than one person giving the guarantee, liability will be “joint and several”. This means that the bank can choose to sue any one of the guarantors, or some or all of them. The bank doesn’t have to sue each person for an equal share of the amount due.
- Some guarantees contain a right of set off that allow the bank to set off money you owe against property of yours that the bank holds. In short, this means that if you have cash in a personal account with the bank and you owe money under the personal guarantee, then the bank could take the cash to pay off the money you owe.
- The bank doesn’t have to bring a claim against the company before claiming against you personally. In reality, the only time the bank is likely to use the personal guarantee is if there’s no money in the company; however, the bank doesn’t have to claim against the company first and could come straight after you.
- Not understanding is no defence. If you don’t understand any clauses in the guarantee, ask your solicitor to explain it!
Charge over Property
The personal guarantee gives the bank the right to sue the individual guarantor for money owed by the company. However, this is of little value if the person giving the guarantee has no assets with which to repay the bank. As a result, personal guarantees will often be supported by a charge over the guarantor’s home. In a worst case scenario, if the company can’t pay and the individual guarantor has no other assets, then the bank could enforce the charge over the home to recover the money due.
If the family home is owned by husband and wife, but the guarantee is only being given by say the husband, then the charge will only relate to the husband’s share of the house. If there is already a mortgage on the house, then the bank’s charge will be second in priority behind the existing mortgage, so the bank security is effective the husband’s share of the equity in the property.
The bank may also take a charge over the company’s assets. This is called a “debenture” or “charge”. If a personal guarantee is being given, then it is worth making sure that the bank also takes a debenture or charge over the company’s assets. This is because if things go wrong, the debenture moves the bank up the priority list in terms of who gets paid first. This makes it more likely that the bank will be paid by the company and so less likely that they will have to enforce the personal guarantee.
Tips for a Successful Application
To finish, here are my top tips to make sure your application for funding goes through smoothly:
#1 If the bank has a franchise team, use them! Franchising is a niche area and it will be helpful to apply to people who understand the industry.
#2 Make sure you thoroughly understand the business plan you are presenting at the application. Don’t rely on any plans or projections given by the franchisor, but do your homework and verify your own figures.
#3 Don’t be disheartened if the bank turns you down. The franchise teams at the bank work closely with franchise networks and may have access to information that you don’t have. If the bank turns you down, try to find out why.
#4 Allow plenty of time. The process of applying for funding, having the application approved, getting the documents issued and completed and funding being made available always takes longer than you think.