What do rising interest rates mean for aspiring franchisees?
As the quest to tackle inflation continues, central banks across the world have increased interest rates to an extent we haven’t seen for decades. There comes the need for business owners to consider how a turbulent economic world affects their position. That includes aspiring entrepreneurs who should keep abreast of the external factors affecting their journey to establishing and sustaining a successful business.
Interest rate rises don’t necessarily affect the value of a business. But chances are a business will see a change in cash flow, given that the purpose behind higher interest rates is to compel people to spend less on goods and services, slowing price rises.
A dip in revenue could make it more difficult to service a loan, and that’s why banks can be more wary of lending during economic hardship. It means that those looking to undergo a new business venture should expect the banks to offer loans with a lower loan to value ratio. In 2007 and 2008 when the major banks had issues with their ability to lend money, they reduced their loan ratios. The good news is that banks look favourably on franchise businesses due to their high success rate and will often provide 80% loan to value which is considered extremely good.
Loan to value ratios determine the deposit that a borrower should put down to secure a loan. A low loan to value ratio means having to pay a bigger down payment. When interest rates rise, banks are wary of it being more difficult for borrowers to service loans, and that’s why you’ll need to pay a greater deposit – but you will have more equity in your business.
If you’re looking to buy an existing franchise business, think from the seller’s perspective too. Inflation can affect how the owner intends to sell. Deferred payments, earn outs, and long reconciliation periods might be something they consider in stable economic times and could assist you in buying a franchise. But when interest rates have skyrocketed, it becomes less attractive and might no longer be an option. That’s because the value of the funds you use to buy the business will only decrease over time. The seller might want the funds in one go, giving them chance to invest it while they can get more bang for their buck.
But while economic uncertainty is relevant, the one thing you can count on is the value of owning a franchise, as opposed to going it alone. Running a franchise means running something that has already proved itself to be a successful model and receiving the support of a headquarters. In the eyes of the lenders, you’re normally considered safer than someone who wants to start from scratch.
Keep that aspiration to own a franchise and start a business alive. But don’t forget about how changes to interest rates can affect your journey to getting there and of course all this ebbs and flows and is often cyclical – so there are always the good times.
