Franchise financing: what to assess before you buy

Buying a franchise with borrowed money requires two separate assessments: whether the outlet is viable and whether you can repay the debt. A well-known brand does not remove interest costs, opening delays or months of weak sales. To enter the franchise sector on a sounder footing, assess the financing as a commitment separate from the network’s commercial promises.

1. Define what you will finance and when the money will arrive

Before seeking credit, separate your costs by purpose: joining the network, fit-out works, equipment, opening stock and set-up expenses. Identify which you will pay from your own funds and which will depend on borrowing. Not every lending facility covers all these expenses.

Create a payment schedule showing three things for each payment: the due date, the source of funds and any conditions that must be met before funds are released. Equipment finance, for example, may require documents from the supplier and pay the funds directly to them, rather than making cash freely available in the business’s account.

Check the following with the lender:

• Who will be the borrower: you personally or the business?
• Which expenses can be financed, and what evidence will be required?
• Will the funds be released in full or in stages?
• Which conditions still need to be met for final approval?
• How long is the offer valid?

Do not treat an illustrative quote, approval in principle or a referral from the franchisor as guaranteed funding. If the purchase depends on credit, take legal advice and negotiate a clear contractual condition covering that dependency, including a deadline and what happens to any money already paid.

2. Compare the full cost, not just the repayment

A lower instalment may conceal a longer term, additional charges or a large final payment. Compare offers based on the same net amount received and, wherever possible, equivalent repayment terms.

Ask for the Custo Efetivo Total (CET), Brazil’s total effective cost measure, where applicable to the transaction, together with a breakdown of its calculation. Regulations issued by Brazil’s National Monetary Council require its disclosure for covered lending transactions involving individuals, sole traders, microenterprises and small businesses. The CET brings together interest and other costs included when the loan is arranged; it is not the same as the advertised interest rate.

Even where the applicability of these rules needs to be assessed individually, request a full schedule of fees, taxes, insurance, costs associated with security and the amounts of all repayments. Also check whether the loan is linked to a variable index and how changes affect the outstanding balance or payments.

Any grace period deserves particular attention. Ask whether interest must be paid during this period, whether charges will be added to the balance or whether another arrangement applies. A grace period does not mean free credit: the debt may grow before the outlet starts generating revenue.

Also check the terms governing early repayment, late payment and circumstances in which the lender can demand repayment of the outstanding debt ahead of schedule. Do not assume that all business borrowing follows the same rules as a personal loan.

3. Test repayments against the outlet’s cash flow

Do not compare repayments with gross turnover. The money available to service debt is what remains after operating expenses, taxes, franchise fees and other commitments needed to run the business.

Ask your accountant for a monthly forecast showing cash inflows, operating outflows and loan repayments separately. Include realistic pay for your own work: removing this expense simply to improve the forecast creates an artificial picture of viability.

Test at least three scenarios:

• Delayed opening: expenses begin before sales, while the loan repayment schedule continues as agreed.
• Sales below forecast: revenue falls, but a substantial share of costs remains.
• Lower margins: discounts, losses or higher costs reduce the cash left over.

In each scenario, identify the months with a cash shortfall and where the money to cover it would come from. If the solution depends on taking out another loan that has not yet been approved, the plan remains vulnerable. Reducing the amount borrowed or choosing a less expensive operating format may be more prudent than extending the debt term.

4. Review security requirements and coordinate the two contracts

The franchise agreement and the loan agreement each impose their own obligations. Do not assume that closing the outlet, disputing a failure by the franchisor or leaving the brand will suspend repayments to the bank.

Review the required guarantees and security with a lawyer, including Brazilian arrangements such as aval (a guarantee on a debt instrument), fiança (a surety guarantee) or alienação fiduciária (a fiduciary transfer of title as security). Understand which people and assets are exposed, for how long and in what circumstances enforcement may occur. If business partners or family members are involved, everyone should understand the extent of the commitment before signing.

In Brazil, Law No. 13,966/2019, the Franchise Law, requires the Franchise Disclosure Document, known as the Circular de Oferta de Franquia (COF), to be provided at least ten days before the franchise agreement or preliminary agreement is signed, or any fee is paid to the franchisor or a person or company connected with it. An urgent credit offer does not override this statutory period.

If the franchisor itself offers payment by instalments, ask for written confirmation of the upfront price, charges, guarantees or security required, and the consequences of late payment. Instalment arrangements with the franchisor also commit future cash flow.

Practical conclusion: proceed only when financing has actually been approved, you understand the costs, the guarantees and security have been reviewed, and repayment capacity has been demonstrated even under adverse scenarios.