While bank interest rates are currently on record lows in our country, a number of potential franchisees are unable to get the finance they require to purchase a franchise.
That’s when they turn to family and friends and other non-banking lenders. Studies indicate that almost 10% of new franchise businesses are now either underwritten/funded by financing from family. The Franchise Advisory Centre has termed this the BOMAD (Bank of Mum and Dad).
Banking institutions are very unemotional and methodical while evaluating any loan application; they will eventually price the risk they take based on the security the borrower offers, as well as their ability to service the loan. In most cases, the security requirement is related to any real estate the borrower owns, such as their home etc.
The other part which is the servicing requirement is then estimated based on that business’ ability to generate a sufficient amount of cash to repay that loan and meet any other obligations that go with it. In addition, a reasonable rate of return has to be paid to the operator as well. In comparison, BOMAD is generally based more on emotional considerations rather than on just financial ones.
If an applicant’s parents underwrite a loan that’s provided by a banking institution, they have to provide personal guarantees. In some cases, they may also put their real estate up for security; but then they have to bear the secondary risk in case the franchise fails and the loan doesn’t get repaid. In comparison when the BOMAD are the loan providers themselves, in case the franchise fails, they bear the primary risk. This can have a negative impact on the relationship between the franchisee and his/her parents.
If you are considering BOMAD financing, you must consider all the advantages as well as the disadvantages as it will help you make a more well-informed decision.
The younger generation has the ability to run a business and they are tech savvy and enthusiastic as well, but they don’t always have the real estate to put up as security if they apply for financing from a bank. In comparison, the older generation (which may be approaching retirement age) have a certain amount of real estate equity; but it may not be enough for purchasing a business. However, when both these generations work in tandem; they are able to get into the franchising business in a more stable manner.
This type of a loan isn’t treated with the same seriousness that bank financing is treated. If a franchisee has taken a loan from a bank and miss any of their repayments or even default on their banking loan, there can be a number of adverse consequences. However, these consequences are generally absent from BOMAD loan. In fact, there may be no documentation at all between the involved parties.
It also means that since the cost of failure is lower, the franchisee may not have a very high drive to succeed either. This isn’t a very good recipe for success; if the franchise fails and the person loses money, they may not be too concerned about it, which can upset the relationship between the family members.
In some instances, the parents might end up running the business and may take complete control in case they feel that their son/daughter aren’t handling the franchise well and the business is underperforming. However, if there is perfect understanding between the franchisee and their parents, they both can bring their best to the table. With consistency and hard work, it is possible to make your franchise a success, even when you have opted for BOMAD financing.
If you want to know more about setting up franchise business or want some advice, feel free to get in touch with us at The Franchise Institute. You can call us on 1300 855 435 or fill in this contact us form and we’ll reply as soon as we can.
Thanks for reading,
The Franchise Institute Team
1300 855 435