QUESTION 11.

A new business customer of your bank and its prospects seems to be bright. As a lender, you are
faced with the customer’s request to finance the business. However you are aware that new
businesses are very risky.

a. What makes a new business Risky?

ANSWER.

A New business is Risky, in acquiring a Startup loan due to the following reasons;

Limited Capital. Capital is the business assets which are used to generate/create
products/services/income for the business. These assets can also be turned into cash and used for
loan repayments {Assuming that its loan application is approved for loan provision}.However, in
most cases the newly started business have limited capital {assets} which are expected to
produce Returns in long term basis only to cover the investing costs incurred during the
establishment of that business, thus unsuitable for loan repayment Criteria.

Low Repayment capacity. Most newly established businesses have less than one year
period in operation thus most of their financial records are Un-satisfactory, therefore lenders find
it difficult to estimate the Capacity of the business to repay loans they applied for. Many lenders
prefer that the borrower to produce financial statements and other related information for 2-3
consecutive financial periods, in this way the assessment of Repayment capacity is easily
measured.

Limited/Little/No Collaterals. When applying for a Secured Loan, the Borrower is

required to put forth Collaterals to pose as securities and assurance to the lender when the Loan
repayments becomes absolute,Now,newly establish businesses are risky for loan provisions due
to Limited collaterals or Absence of collaterals at all (in case of un-secured loan),and therefore
the lenders are forced to denial the loan provisions due to uncertainty of securities that may
hinder loan repayments when called for payments.However,the new business owner can use
his/her personal assets as collateral, or can pledge with a consigner with assets.

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 Lack of Experience.For, professional businesses, it is common for lenders to deny a
startup. Loan as a result of less than a year experience in operation of the business. Experience is
one amongst the core criteria required by the lenders to borrowers because the higher the level of
experience, the higher the assurance to loan provisions since the lenders are constant that the
consistency of the borrower in a particular business for a number of years makes him/her
adaptable to various measures to account for insecurities that they may have encountered during
the time of operations such as losses,inflations,currency destabilizations and others in which the
borrower made it through. Unlike a new business whose certainty of safe mechanism defense to
such insecurities is unknown.

In-competent Management. Lenders may not be compatible with a new business that
has no strong Experienced and accountable management which may put it in a risky usage of
loan Granted(assuming that the lenders Grants the Loan applied they for).

b. What points should a lending banker consider when requested to a new business?

ANSWER.

Purpose of the Loan. First, the bank would analyze the borrower’s business to see if it
is solid and that the borrower has a strong track record of performance. The lender also would
asses the likeness of what the borrower would do if he/she was granted the loan and if the
borrower is specific about how much money he/she needs, what he/she will do with it and how
he/she will pay it back.

Character. The lender needs the confidence that the borrower has the experience,
education and industry knowledge to successfully manage the business. The borrower's
reputation plays a significant part in getting a bank loan. Your credit history will show your track
record for repaying debts.

The Need for Collateral. When a lending bank makes a loan, it determines a plan of
how the borrower will repay the loan. If the borrower defaults on the loan, then the bank falls
back on the collateral. A lender never wants to use the collateral to repay a loan, because the sale
of the collateral may not be enough to pay off the loan.

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Banks like to take property and assets as collateral as a way to recover their loan in the event the
borrower fails to pay as planned.

Capacity to Repay the Loan.The borrower must show that he/she can repay the loan out
of the business’s cash flow. The bank will analyze the business’s debt-to-income ratio and the
amount of its free cash flow. Lenders like these ratios to provide a cushion in case the business
takes a downturn.

The Need for Capital. Lending Banks feel more comfortable when the borrower has
his/her own money invested in the business. Lenders like to know the owner will lose something
if the business fails. If the owner is not investing in his own business, the bank would not invest
also.

Overall Economic Conditions. Besides analyzing the borrower, lending bankes will
look at the overall economy, industry trends and even the direction of politics,taking into
forcasting on factors beyond the control of the business owner that will affect the performance of
the business.

It is almost impossible to start a new business and finance its growth solely with internally
generated funds and owners' capital. At some point, small business owners will have to approach
their banks for loans. Understand the process that bankers go through to evaluate their risks
before you apply for a loan.

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 c. A Business is thinking of Entering into a Franching agreement with one of a very
established firm in its line of business.
Required.
I. Describe the Term franchising.
ANSWER.

FRANCHISING.

Arrangement where one party(the Franchiser) grants another party (the

franchisee) the right to use its Trademark or Trade name as well as certain business trade systems
and processes to produce and market a good or service according to certain specifications. The
Franchisee pays a onetime Franchise fee plus a certain percentage of revenue/sales as royalties.
Examples of Franching Agreement in Tanzania are; Bonite Bottlers-Coca cola, KFC,Mr Price
and others.

II. Explain any four advantaged and four disadvantages of franchising

Agreement.
ANSWER.

i. ADVANTAGES TO THE FRANCHISOR;

Product Promotion. By Franching Agreement, The franchisor gets to promote his/her

product further into the market scopes and its markets ground, simply the franchisor increases
his/her scope of production and markets.

Risk Management. The franchisor can easily control risk that can be encountered during
business such that if it was to incur a risk then both the franchisor and the franchisee are both
accountable for the risk, thus split the risk base which makes it easier to control and combat the
risk compared to if it was to bear the risk by its own.

Improved product Quality. Since the franchisor will be the one to supervise the franchisee
and to allocate specialization to the franchisee on how to produce the products or services, thus
increasing and improving the quality and furthermore the standard of its product or services
under its trademark/trade name.

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 Increase Profitability. The Franchisor will also be enjoying the rate of return from products
and services as a result of increasing market scope, which will call for increase in quantity
produced to utilize the extra market scope acquired as a result of business extension, hence
promising positive Rate of Return (Profit).

ii. ADVANTAGES TO THE FRANCHISEE.

Technology Transfer. The Franching agreements comes with set of production procedures
which may require the existence of certain technology as used by the Franchisor to produce
products or services to match and produce quality and standard products to safe guard its trade
mark or trade name. Therefore the Franchisee adapts various production techniques and
technology that may be new to its markets and its scope of production hence an advantage.

Leverages. These are such as Loans from banking institutions, Insurance Benefits,
Workers/employee’s benefits, Bonuses and allowances and others as can be specifies in the
terms of the agreements.

Established Markert.The franchisee as no need to find market (market testing) for the
products he/she produces on behalf of the franchisor since the market is already established
through experience, Reputation and strength of the trade mark or trade name of the
Franchisor.Example, market for Coca Cola soft drinks.

Training and Support. The Franchisee gets all forms of training and supports from the
franchisor which may be specified in the terms of the agreements, such as employee trainings,
financial support, materials support, recruitment facilities and others.

Competitive Edge. In this, the franchisee is able to compete with other bigger businesses in
the same line of production.

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 i. DISADVANTAGES TO THE FRANCHISEE.

Lack of Independence. Buying(licensing) a franchise means working within a system in

which there is little freedom or scope to be creative .Almost every aspect of operation is laid
down in manuals as instructed by the franchisor.

Franchisor monitoring. Regular field staff monitoring visits becomes very intrusive as time
passes by thus limiting self trouble shooting of your own business as a result of the franchisor’s
intrusive interests.

High Service Fees. These fees are at the beginning very essential to the franchisee to pay but
as time goes on these fees becomes cost full due to franchisor’s requirement such as management
fees and the fee for use of the franchisor resources(even when not required or used)by the
franchisee.

Inflexibility. Franchising tend to be an inflexible method of doing business as each

franchisee is bound by the franchise contract to operate in a certain customary format. This
makes it difficult for the franchisee to introduce changes to the business to suit the requirements
of the market at various periods.

Risk associated with the franchisor. It is important to know that not all franchise business
are run smoothly and are soundly based thus when signing the agreements the franchisee may
be affected by the ethics and which kind of franchisor(The established franchisor, The new
franchisor, The unethical Franchisor, The incompetent franchisor) in which him/her is
bonding to.

ii. DISADVATAGES TO THE FRANCHISOR.

Reputation. The franchisor can be affected by the Franchisee since the effects affects the
whole system of the agreement depending on the franchisee’s performance and ability. In most
cases Franchisee tend to deplete the quality of the products and services produced thus effecting
the franchisor’s reputation in the market and can even deplete its production scope.

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 REFERENCE.

S.A.Butt,(2001),Essentials Of Commerce In East Africa.(5th Edition)

www.businessinfo.co.uk ,visited on 23/05/2019.

www.whichfranchise.com , visited on 23/05/2019.

www.theballincemb.com , visited on 23/05/2019.

www.businessdictionary.com , visited on 23/05/2019.

www.franchise.com , visited on 23/05/2019.

https://smallbusiness.chron.com , 23/05/2019.

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