Financing and Franchising
Financing of a New Firm
• Capital needs
– Prior to begin of operation
– Working capital
– Expansion and Capital Projects
• Allocation of values
– Founders
– Investors
Capitalization Needs
• Undercapitalization
– Inability to perform as per business plan
expectations
– Cash crisis
– Legal default
• Overcapitalization
– Excessive cash leads to inefficiencies, takeover
interest
– Skewed expectations of investors
Working Capital
• Permanent Working Capital
– Capital required to produce at the minimum
plan level
– No consideration for extraordinary
expenditures
• Temporary Working Capital
– Meeting seasonal/cyclical demand
– Special capital expenditures
VC Capital Stages
•
•
•
•
•
Seed Capital
Start-Up Capital/First Stage
Second Stage
Third Stage
Fourth Stage
VC Capital Stages
• Seed Capital
– Is the concept viable?
– Little/no payment to founders
– Heavy on market research/ contractual
relationships
•
•
•
•
Start-Up Capital/First Stage
Second Stage
Third Stage
Fourth Stage
VC Capital Stages
• Seed Capital
• Start-Up Capital/First Stage
– Organization
– Operational to first commercial sale
• Second Stage
• Third Stage
• Fourth Stage
VC Capital Stages
• Seed Capital
• Start-Up Capital/First Stage
• Second Stage
– Initial working capital for serial production and
sales
• Third Stage
– Capital to get to break-even point
• Fourth Stage
– Transition to public ownership
Equity
• Reasonable relationship between equity
and contribution
• Protection against unintended
shareholders
• Rights to sell/buy shares
• Dilutions
• Shares as incentives
Cashflow Management
• Practical
– Actual versus Plan
– Payable Days
– Cash-at-hand
• Emotional
– Comfort zone
• Leadership
– Concern for expenditures
– Leadership by example
Cash Factors
•
•
•
•
•
Accounts Payable
Accounts Receivable
Raw materials inventory
Work-in-Progress inventory
Finished Goods inventory
Cash Factors
• Accounts Payable
– Repetitive payments
– Vendor invoices
– Internal expenses, i.e. payroll, expense
reports, bonuses, shareholder distributions
– Scheduled reserves
Cash Factors
• Accounts Receivable
– Current invoices
– Overdue invoices
– Scheduled invoices for products about to
be delivered
– Payment incentives
– Direct Debit payments
Cash Factors
• Raw materials inventory
– Just-In-Time versus bulk discounts
– Information Systems
– Sales forecasting
– Goal: MINIMIZE
Cash Factors
• Work-in-Progress inventory
– Efficient operations
– Worker training
– Capital investments
– Goal: MINIMIZE
Cash Factors
• Finished Goods inventory
– Accurate sales forecasting
– Information systems
– Buyer relationships
– Goal: MINIMIZE
Equity Financing
• Inside equity
– Founders, top managers, friends
• Outside equity
– Non-professional investors without close personal
relationships
• Venture capital
– Professional Investors
• Public/Merger Firms
– Stock Market/Corporate World
Debt Financing
• Asset based borrowing
– Collateralized (assets, trade receivables)
• Cash flow borrowing
– Unsecured
– Based on ability to generate cash
– Convenants
Valuation of a firm
• Asset based
– Value of sold assets
– Disregard book value
– Lowest risk: Liquidation value
• Earnings based
– Historical earnings
– Future earnings
• Discounted Cashflow
– Cash generation
Franchising
Definition
• A franchise is a legal and commercial
relationship between the owner of a
trademark, service mark, trade name or
advertising symbol, and an individual or
group seeking the right to use that
identification in business.
• The franchise governs the conduct of
franchisor and franchisee.
Two forms of franchising
• Product/Trade Name Franchise:
Right to name or trademark.
• Business Format Franchising
Broader relationship which includes
extensive agreements as to all aspects
of the business operation.
Conversion Franchises
• Take an existing business, likely in the
same business area as the franchise,
and convert it into a franchise.
•
•
•
•
•
•
The
Franchisor’s
View
Expansion Capital provided by the franchisees.
Franchisees provide motivated local management.
With franchising, franchisors can expand faster.
Proven concept and some uniqueness required.
Trademarks must be protectable.
Initial capital required for pilot/training.
Franchise Information Needs
•
•
•
•
•
•
•
•
•
Full initial costs
Licensing fees
Land purchase/lease
Building construction/renovation
Equipment
Training
Starting inventory
Promotional fees
Use of operating manuals
Franchise Information Needs
•
•
•
•
•
•
•
•
•
Continuing costs of the franchisor
Royalties
Ongoing training
Cooperative advertising fees
Insurance
Interest on financing
Requirements to purchase all supplies from specified sources
Competition restrictions
Renewals, sales, terminations
Franchise Satisfaction
• Benefit of a known trade name, higher
independence and job satisfaction than a
salaried employment, and ease of
development were the primary advantages of
franchising, according to franchisees.
• Willingness to work hard and desire to
succeed were viewed as important
characteristics of successful franchisees.
Knight 1986
Entrepreneurs vs. Franchises
• Independent entrepreneurs were
perceived to be more self-reliant,
experienced, independently minded and
highly motivated than franchisees.
• The author also comments that
franchisees can have a high failure risk.
Knight 1984
Key Contract Terms
•
•
•
•
•
•
•
More is prohibited than allowed
Any breach cancels the contract
Usual terms 15-20 years
Renewal fees
No guaranteed renewal
Renewals may be at completely different terms
Franchisor usually retains the first right to purchase a
franchise
Rules
•
•
•
•
•
•
•
•
•
Uniformity
Sign approval
Design/appearance
Restrictions on goods/services used
Opening hours
Geographic areas covered
Uniforms
Advertising
Grand Opening
Legal Requirements
• Franchise Agreement
• Franchise Manual
• Lease (if applicable)
Franchise Selection Criteria
•
•
•
•
•
•
Franchisor history and performance
Growth
Terms
Litigation history
Bankruptcies
Costs
Royalty Fees
• IRD rules require Non Resident
Withholding Taxes for Royalties (15%),
Dividends and Interest (30%).
• Amounts are less if NZ and the country
have a Double Taxation Treaty.
• Local business is liable for NRWT
payments.
Franchise Advertising Fees
• US advertising fees are normally around
2-8%.
• Some charge fees on sales, some have
a fixed advertising amount.
• McDonalds charges 4%.
Advertising Fee in Business Format
Franchising, Desai, 1997
Ongoing Payments
•
•
•
•
•
Royalties
Minimum payments
Advertising
Training
Purchase supplies
Franchise Growth
• Franchise growth is at similar pace as
the overall US economy.
• In recession, franchising decreases
along with the overall economy.
• Over 4 years, 34% of franchises failed
versus 28% of non-franchises.
Franchising Growth and Failure in the USA
and the UK, Stanworth/Purdy/Price, 1997
Franchise Failures
• A high number of franchisors are failing.
• The only useful factor to determine
probability of success is how long the
franchisor had been in business before
starting to franchise.
Franchising Growth and Franchisor Entry and
exit in the US Market: Myth and Reality,
Lafontaine/Shaw, 1997
Hot US Franchises
• Visiting Angels
• Sending caregivers to homes ot the
elderly.
• Royalty 2.5%
• Start-Up Capital: $10,000
Hot US Franchises
• Country Clutter
• Country-theme store with gifts,
collectibles, home décor, etc.
• Start-Up Capital: $75,000 cash,
$175,000 total, networth $250,000
Hot US Franchises
• Mighty Distribution System
• Wholesale of automotive parts to
professional automotive service trade.
• Start-Up Capital: $50,000 cash, $90,000
total, networth $250,000
Hot US Franchises
• Delbe Home Services
• Markets one-stop shop for all home
repair/construction services.
• Start-Up Capital: $16,000 cash, $18,000
total, networth $140,000
McDonalds System
• Very tough franchise agreement
• Culture of McDonalds a key ingredient
to successful restaurants
• At least 1 inspection visit per month
• 22,346 restaurants in 110 countries
• One new restaurant opened every 6
hours
• $33.6 Billion sold in 1997
Franchise Definition
• A franchise is a legal and commercial
relationship between the owner of a
trademark, service mark, trade name or
advertising symbol, and an individual or
group seeking the right to use that
identification in business.
• The franchise governs the conduct of
franchisor and franchisee.
Franchise Satisfaction
• Benefit of a known trade name, higher
independence and job satisfaction than a
salaried employment, and ease of
development were the primary advantages of
franchising, according to franchisees.
• Willingness to work hard and desire to
succeed were viewed as important
characteristics of successful franchisees.
Knight 1986