What happens when parents buy their kids a franchise…

Franchisors are noting an increase in the number of franchise applicants who are proposing to pay for their franchise using funds borrowed in part or full from their parents or other family members.

This is partly the result of several economic and social trends, outlined as follows:

The GFC

Banks have tightened their lending criteria in the wake of the GFC and now require more security and a demonstration of the capacity to service a business loan than was required pre-GFC. Additionally, the relatively buoyant housing market in Australia has meant a flow of funds toward home lending that might otherwise have been allocated for business lending. This compounds the difficulty of achieving a business loan when the criteria is tightened and there are less funds available.

The housing market

Unlike the US, England and parts of Europe, property prices in Australia have generally risen – not fallen – during the economic turmoil of the last couple of years. For many Australians, home ownership is becoming increasingly unattainable, and consequently a growing proportion of potential franchisees are unlikely to have any real estate equity to offer a bank as security for a business loan.

Likewise, the growing cost of owning a home given the higher proportion of household incomes now allocated to mortgage payments and utilities makes it increasingly harder for those who have managed to get a toehold in the real estate market to do more than hold on, rather than build enough equity to allow for future borrowing opportunities.

Generation Y are impatient

People born in an age of computer gadgetry and internet connectivity, and who have joined the workforce during the pre-GFC economic boom and times of easy credit are incredibly confident in their own ability to do almost anything. This is often demonstrated by the way they quickly acquire technical skills in new jobs, and change jobs just as quickly.

Rather than waiting until they have acquired the asset base necessary to secure a business loan, they are ready to get into business for themselves now. (And by the same token, if these Generation Y candidates are already working within a franchise as an employee, their talent will be obvious to a franchisor).

However Generation Y is not known for its long-term outlook, and a franchise over five or 10 years may represent a future commitment longer than the time a Gen Y candidate can realistically envisage.

Mum and Dad want to help

Baby Boomer and some Generation X parents, whose share investments have been savaged by the GFC, and who can see bleak wealth creation prospects for their Gen Y offspring given the ever-rising property market, are now actually more prepared to consider lending to their kids as a way of getting them started in life. Many parents treat such loans as an advance on their kids’ inheritance.

But despite all the factors that lead to family financing, one key difference remains between that and traditional bank lending:

A bank will move heaven and earth to get its money back.

For a borrower who uses his house to secure a business loan, the fear of losing the home in the event of a business failure is subtle but powerful motivation to work harder and smarter to make the business succeed. Beyond losing the home is the risk of bankruptcy, bad credit references and so on, with the stigma often attached to these occurrences.

By contrast, if Mum and Dad lend the money to Junior to buy a business and the business then fails, what are the consequences to the child?

Family gatherings at Christmas are likely to be a bit subdued for a while. They might miss out on birthday presents from Mum and Dad thereafter, and other family social gatherings may be a bit awkward, but in real terms, the chances of parents pursuing an outstanding debt with the same rigour as a bank are pretty remote.

And consequently, people who are financed by their parents do not have the same subtle but powerful debt repayment motivation like those who borrow from banks, and in the long run may be less determined to succeed.

One potential outcome of a family-financed business is that parents may be forced to step in to protect their investment as the performance of the business deteriorates, and franchisors could find themselves increasingly dealing with Mum and Dad rather than the child who was granted the franchise.

Such an outcome would be one that neither the franchisor nor the parents of the franchisee signed-up for.

Jason Gehrke is a director of the Franchise Advisory Centre and has been involved in franchising for 20 years at franchisee, franchisor and advisor level. He provides consulting services to both franchisors and franchisees, and conducts franchise education programs throughout Australia. He has been awarded for his franchise achievements, and publishes Franchise News & Events, Australia’s only fortnightly electronic news bulletin on franchising issues.