Starting a franchise is an excellent way to begin your journey in the business world without having to plan everything from the ground up.
While some entrepreneurs like the idea of creating a brand from scratch and building from there, others prefer a pre-established route, such as a franchise. A franchise setup essentially trims the number of steps you’ll need to undergo before you can enjoy the benefits of a healthy revenue stream.
That being said, as you’ll be riding on the coattails of a pre-existing brand with a loyal fanbase and credible community reputation, being chosen and approved as a franchise operator for the company can be quite a bit troublesome.
And even if you do get approved, by far the biggest challenge in this process is acquiring the necessary funding to operate the business franchise. Besides the initial application costs, you’ll also have to pay for a variety of business costs out of pocket—which can be a drain on your wallet.
In a lot of cases, many franchisees seek out financing options to help them weather the storm of expensive franchise costs. The good news is that there are many financing options that prospective business owners can leverage to give themselves a financial boost for their operations.
So without further ado, let’s delve into the reality of the cost of capital and the impact of borrowing on a franchise model in greater detail.
What Is the Cost of Capital?
Essentially, the cost of capital refers to the minimum return a business needs to earn to justify the cost of acquiring funds.
When borrowing money, you’ll acquire debt, which comes with its own respective interest payments, lender fees, and miscellaneous fees. To compute the cost of capital, these fees are added together and compared against the expected returns generated by the investment.
Knowing the cost of capital allows business owners to determine whether borrowing is financially worthwhile. It also helps businesses determine whether it can produce enough profit to cover its financing cost.
When the cost of capital is clearly laid out, business owners can make more informed financing decisions with the resources they have access to, such as deals involving personal loans with Westpac. Furthermore, a clear cost structure also helps business owners set realistic expectations that fit their goals and objectives, making them more likely to reach long-term success.
The Components of the Cost of Capital
Franchises are fundamentally businesses, but they have special considerations and associated costs as they differ from traditional brands built from the ground up.
Here are some of the key components that make up capital costs when starting a franchise business:
Initial franchise fee: This fee is for the rights of owning and managing a franchised brand. The range of this cost can range anywhere between $20,000 and one million dollars depending on the popularity of the underlying franchise.
Equipment and construction work: Franchise-grade equipment, as well as store-specific renovations, must also be accounted for when computing the cost of capital.
Initial inventory: This refers to the stock and supplies your business needs before doors open during its initial week.
Professional fees: This fee is set aside for professional services needed to operate the franchise business, such as legal fees and auditing fees.
Capital buffer: This budget is set aside to cover the early set of operational and labour wages, as well as rent, for the first 3 to 12 months.
Royalty: Royalties refer to the regular ongoing fees paid to the franchisor, usually about 5 to 10% of the business’s total gross sales.
By knowing these cost factors, prospective business owners can develop a good understanding of their expected costs, giving them a more concrete idea of how much they’re expected to spend for their franchise within a specific time horizon.
Types of Borrowing Available for Franchise Financing
There are multiple ways franchisees can borrow finances to fuel their business’s launch and operations.
Here are some ways these business owners can access financing:
Franchise financing: This type of financing is dedicated exclusively to franchisees, covering up to 70% of the total cost of setting up the franchise.
Traditional bank loans: Banks typically offer competitive interest rates and longer repayment terms to qualified borrowers.
Personal loans: Some entrepreneurs use personal loans to finance their franchise investment, either in part or as a whole. They can be obtained quickly, but they often come with higher interest rates than traditional loan structures.
Online lenders: This pathway offers the fastest application process, and it also allows people with less-than-stellar qualifications to apply. That said, interest rates and repayment terms may be less optimal than traditional financing.
How to Improve Chances of a Good Borrowing Amount
Any franchisee can apply for a loan, but the loan amount they’d be given won’t be uniform across all applicants. There is some variability involved in the process as various factors are in play that affect it, including the following:
Credit score: Having a high credit score gives borrowers better financing terms and lower interest rates, putting them at a lower risk of incurring unmanageable debt.
Loan amount: Lower loan requests usually mean a lower amount of interest paid over time.
Repayment period: Longer repayment terms reduce monthly payments, but they increase the overall borrowing cost due to having to spend more for interest.
Market interest rate: Economic conditions influence lending rates, making the timing of your loan application an important thing to consider.
By knowing these things, you can build your profile and get a better loan deal from your applications. All the best in running your brand new franchise!
Disclaimer: This article provides general information only and does not constitute financial advice. It does not consider your individual objectives, financial situation or needs. You should obtain independent professional advice before making any financial decision. References or links to third‑party products or websites are provided for general information purposes only.
