Two years ago Daniel and Mmangatane Motsuweni paid R350 000 to buy a Hot Dog Café franchise. After some problems in the first year, their business is up and running and makes them a steady income of R40 000-R50 000/month. (See story next page.)
The Motsuwenis are part of one of SA's fastest-growing business markets - the franchise system, which is not only creating a significant number of jobs but also developing entrepreneurs, particularly in the black community.
Each year about 3 200 outlets are opened, ranging from the largest, such as McDonald's and KFC, to smaller operations in sectors such as tyre manufacturing, telecommunications and waste management. A total of 23 000 franchises are currently in operation, estimates Kobus Oosthuizen, vice-chairman of the Franchise Association of Southern Africa and a director of Butterfield, a 130-strong bakery franchise.
The industry has a yearly turnover of almost R130bn, contributes 11,7% to the country's gross domestic product (GDP) and employs about 300 000 people directly and a couple of hundred thousand among suppliers and contractors.
But despite these strong numbers and the undoubted growth potential of the industry, franchisees struggle to get reasonably priced loan funding for their operations. The problem is becoming particularly acute now that franchise businesses are trying to expand into township and rural markets; the majority of black franchisees simply don't have enough cash to put down the required deposits to secure loan funding.
The Industrial Development Corporation's (IDC) franchising unit is trying to plug the gap, and is doing so with some success, by offering funding that is considerably cheaper than commercial bank financing. In line with the IDC's November launch of its Pro-SME Jobs scheme, financing to franchise operators can now be priced as low as five percentage points below prime, says Hilton Lazarus, head of the unit.
Even before the pro-jobs launch, IDC lending to the market had risen steadily. Between 1999 and October 2003, when franchise funding was part of other business units, the IDC approved R300m in financing for the sector. This has increased consistently since then and in the financial year to end-March 2006, the IDC funded 97 entrepreneurs by R205m, creating an estimated 3 250 jobs. In comparison, its R110m in funding during financial 2004/2005 was responsible for about 1 730 jobs.
"The franchising industry has the potential for significant job creation, and also supports small enterprises and entrepreneurial activity," says Lazarus.
He envisages increased lending over the next few years. "We see major opportunities for the sector as franchise businesses depend on property development such as shopping centres and malls, which promote high traffic. And property projects, particularly in rural areas and townships, are taking off."
The expansion into townships and rural regions will also enable the IDC to meet its target of an 80% exposure to black empowered (BEE) franchises from its current level of about 64%.
The key funding tool offered by the IDC - a wholesale funding facility to the franchise business which onsells it to its franchise operators - is aimed in particular at facilitating greater empowerment. Before the pro-jobs initiative this was priced at prime minus two percentage points and has since been lowered to five percentage points below prime. This wholesale facility has made the IDC one of the largest funders in the franchise industry.
The IDC has partnerships with about 18 franchisors including Nando's, Spur, Mike's Kitchen, Hot Dog Café, Butterfield, Pick 'n Pay and companies such as Woolworths Textile Stores and Sasol.
Establishing or buying a franchise is not cheap. For example, the cost of buying a restaurant franchise from Spur, Dros or Mike's Kitchen can vary from R3m-R5m. Garages are in a similar range. A Nando's franchise is about R1,5m and from there on it gets slightly more affordable with a Butterfield business costing about R750 000 and a Hot Dog Café about R300 000, one of the cheapest available franchises at present.
The biggest problems facing franchisees, particularly emerging entrepreneurs, is paying the upfront deposit and meeting the monthly repayments, particularly in the first year of operation. Apart from interest payments the franchisor has to fund stock, rentals and other running costs. And a percentage of turnover - about 10%-12% on average - goes back to the parent business to pay for marketing, IT systems, central procurement and other support.
Lazarus says his unit's wholesale facility seeks to address the payment issues. For one, the cost of funding at prime minus five is significantly lower than commercial lending, which is normally a couple of percentage points above prime. Almost all of the funding is in terms of a facility to the franchise business, which then onlends it to the franchise operators.
Franchisees are also offered a one-year capital holiday and a six-year repayment period. The upfront commitment remains, but at only 10% of the total costs, though this is raised depending on the risk assessment. Lazarus says though that the IDC is looking at providing a facility of less than R300 000, where his unit would provide the entire amount without requiring a deposit.
In providing such cheap funding the IDC has set a number of fairly tough conditions. The franchisor needs to be closely involved with the business, ensuring that the site selection, training and marketing support is strong. Furthermore, stringent due-diligence studies by the IDC should ensure that both its development criteria - such as job creation - and financial viability are all but guaranteed. With a bad-debt experience of about 4%, only marginally above that of commercial banks, the IDC seems to have achieved that to date.
Alternative financing packages available to the industry are generally more expensive. Commercial bank lending comes usually at rates above prime and banks require a guarantee that is offered through the department of trade & industry's Khula SME agency, which compensates them should the franchise go bust.
Venture capital firm Business Partners also offers funding, though it often takes a large equity stake in the business, reducing the revenue flow to the franchisor. But, says Oosthuizen, Business Partners provides progressive mentoring and management support.
There are some concerns about the IDC's wholesale facility; as part of the pro-jobs package the IDC is taking on a lot of the administration linked to lending, such as payment collection - a job previously done by the banks.
"There is a worry that they don't have sufficient resources to do this efficiently. They should rather outsource the administrative aspects of their package," says an industry source.
