3 Common Ways To Obtain Working Capital For A Franchise

Published on February 10, 2014

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Franchises need working capital. Just like every other business on this planet. Not all businesses need equipment. Not all businesses need inventory or commercial property or even labor. But, all businesses need working capital to ensure that their operations are running smoothly enough to generate revenue day-in and day-out.

In fact, that is what working capital means – having enough money on hand to fund a business’s operations so that it can continue to work and satisfy customers.

The principles behind working capital are simple – even in franchises. A manufacture may need raw materials and the ability to run its factory in order to complete a customer’s job before it gets paid. Thus, it has to have that money on hand to purchase those materials as well as to cover its utilities, supplies and labor so that it can change those materials into a finished product before shipment. Without having that cash (that working capital) on hand, that business would never be able to start a new job order let alone complete and ship its finished product (and ultimately get paid).

Restaurants and services businesses are no different. They have to have money on hand (capital on hand) to purchase needed supplies, labor, materials or whatever they need to satisfy their customer’s wants and needs. Retail businesses have to have inventory to sell before they can collect payments and earn revenue. Home based businesses need to have money ready and available to ensure that they can delivery on the promises they make to their customers. And, lastly, even professional business owners – including those without employees – still have to be able to cover their costs and supplies while they provide their professional services.

And, since franchises can be all of these types of businesses – then by default, franchises also need working capital to make their companies successful – even if the franchisor can or is willing to provide some of these needed items to their franchise partners, those partners still have to cover the cost of those items until they can complete jobs or resell those products for profit.

In essences, working capital is the life blood of all businesses. And, having a lack of working capital available is probably the quickest way to destroy a business – even a growing franchise.

In fact, over the last few years, we have heard about how hard it is and how fatal it can be when a business, of any size, cannot access the capital it needs. And, more times than not, these companies are talking about their ability to obtain needed working capital when and where they need it.

So, if your franchise is in need of working capital, where should it turn?

The answer is simple: The business can turn to any source of lending that is available to it; to include these 3 common methods of working capital financing:

1) Bank Loans: Almost all banks offer some form of an operating line of credit – used primarily for working capital. These credit facilities work very similar to that of a big credit card. The idea behind these lines of credit is to provide a business or franchise an open and ready credit line that can be drawn upon when needed (at any time) and then be repaid after the business’s operations earns revenue – taking that working capital, completing jobs or selling inventory and then getting paid itself.

However, like all bank loans, these credit lines can be hard to come by with the new, higher standards that banks use to underwrite their business loans these days.

Most banks will require that your business (your franchise) be in operations for at least two years prior to applying for a loan or line of credit. Further, these lenders will also require that the business be profitable – probably for those same two years.

However, on the other side, banks do tend to be a bit more lenient with franchise businesses as they know that those business models work (and work well) and usually come with the support of the franchisor and their entire system. But, the franchise will still have to qualify on its own.

So, if your business does qualify or can find a way to qualify, bank lines of credit are usually the cheapest and most flexible working capital product on the market today.

As just one example, Wells Fargo Bank offers four distinct lines of credit for small businesses including franchises. These range from secured credit lines to unsecured facilities, can have terms up to 5 years depending on the business’s wherewithal and can be for amounts ranging from $5,000 to $500,000.

2) Alternative Loans: By now, you probably have heard of alternative business loans or asset based financing (two of the same). These loans are designed for just this need – working capital.

These credit facilities are underwritten and approved – not based on the business’s overall level of revenue and profitability – but on the working operations of that business; on its ability to generate revenue and nothing else.

Example: A distribution business receives a huge order to ship out a certain product to a new customer. However, that business does not have the cash on hand to acquire those products directly from the manufacturer. So, does it decline the new customer or does it find other ways to get the capital it needs to fulfill that order?

If the business ships products to customers along with invoices for payments and that business has yet to receive all those payments from its past invoices, it could factor those accounts receivables (what invoices become when they are issued but not yet paid) for needed capital to fulfill that next order and then when that invoice or those invoices pay, it can repay that working capital loan.

Or, retail businesses. Most retail businesses – including restaurants and other retail service businesses – take payments from their customers via credit and debit cards. And, if they have a steady volume of these forms of payments – which they should or they have other problems with their companies – then they can get a working capital cash advance based on that volume via a business or merchant cash advance.

And, those funds can be used for any business need – from buying more inventory to covering utilities, labor and marketing or for any immediate business need.

And, it does not end there. For those businesses that only receive cash or other forms of payments from customers, if they have that cash flowing through their company’s bank account daily – there are lenders who provide revenue based loans specifically for businesses (profitable or not) in this situation.

Alternative loans – while short-term in nature – can be a bit more expensive than bank loans or lines of credit. However, these loans – these alternative financing methods – can be easier to obtain (regardless if your business is profitable or not) and should only be used if and when your bank declines your financing request.

One example is a leading accounts receivable factoring company (Bibby Financial Services) that states “Our receivables funding (accounts receivable financing) service means that we can help you improve your cash flow by providing an immediate advance of cash against the value of your outstanding invoices. Then as you raise an invoice, we can release up to 90% of the value of that invoice within 24 hours. The remaining 10% is paid to you, less a small service fee, once we have received payment from your customer.”

3) Trade Credit: Trade credit is like a form of bartering – thus, it does not provide a business with cash per say – cash that the business can then use to buy needed materials, supplies and such. But, what trade credit does is by-passes that middle step (actually getting cash from a lender) and allows the business to get the items it needs directly.

Example: A franchise restaurant – fast food or otherwise – may get the bulk of its food stuffs and supplies directly from the franchisor (through their buying prowess). And, that franchisor may not require the business to pay for those goods right away – allowing the business time to prepare and sell those supplies to its customers – and getting paid for that effort.

However, not all franchisors provide all that their franchises need – especially when it comes to fresh food products or custom items. Thus, the franchise will have to turn to the open market to get those goods. But, if that business does not have the money on hand to buy those products out right – it may then ask those suppliers, vendors or manufactures to take the same stance that their franchisor does – providing them needed products today but allowing them time (days, weeks, months) to convert those goods into cash payments from their customers. Then, at that time – time of payment – the franchise just simply takes part of that revenue and repays those suppliers for their goods.

And, the best thing about trade credit is that, if that supplier really wants your business long-term, it will work with you to create a deal (trade terms) that may not cost your business a single dime in fees and interest (unlike bank loans or alternative methods of financing).

Conclusion

Sure, it may be hard to get a business loan to cover your franchise’s equipment needs – but, you can find a way around that – you are an entrepreneur after all. And, it might be hard to get a commercial real estate loan these days – but, again, you can find a way around that.

But, if your business is struggling to get the working capital it needs to run its operations and grow the company (or even to just get the business to survive day-to-day), you cannot find a way around that. No customers, supplier or franchisor will lease (like with equipment) or rent (like with property) your business’s working capital needs.

Thus, your franchise either has to find a way to generate enough in revenue to cover its ongoing capital needs by itself or set up working capital facilities (loans) or trade terms with outside lenders that understand both how your business generates revenue as well as how it can use its operations to repay those funds – with lenders like the three outlined here.

And, these credit lines, cash advances or trade deals should be set up a head of time so that your business can tap those funds when its needs them and not waste time (time it might not have) to scrounging up those funds at the last minute.


Written by FranchiseGrade.com Team
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