Financing Your New Franchise
Just a few years ago, franchise businesses were opening up on every corner of this country – not to mention around the world in emerging markets. One of the reasons was that it was fairly easy to get financing for a franchise purchase and development.
But, when the great recession hit, nearly 90% of all franchise funding went away, and many past lenders and current banks are still not picking up their franchise lending.
Why? Only those lenders know.
However, on the other side, the franchise industry has remained one of the fastest growth industries – even in the face of this poor economy. Franchises are a very easy path to entrepreneurship. Franchises offer proven business models, established procedures, name brand recognition, economies of scale, as well as shared marketing might.
All key aspects to any business’s long-term success and items that may take years or even decades to develop on your own.
So, if the number of franchises are growing and growing quite well, how are they getting financing to do it?
Let’s first begin by understanding what is required to purchase and thus finance a franchise.
Franchises come in all shapes and sizes. You can purchase a right to franchise for as little as a $1,000 (one that you would probably run out of your home) to several million dollars (one that would require a huge building and lots of equipment).
Now, to finance these businesses, most lenders will look at several things with the most important being credit and cash flow.
Credit and Cash Flow:
Your credit does matter – it always has and always will. Thus, if your credit is not up to par – start here to get it fixed. It does not matter if you are trying to borrow a thousand dollars or a million, without solid personal credit you have no chance – period.
Regarding cash flow. Your franchisor should be able to provide average revenues that each franchise should be able to earn yearly. Lenders will then evaluate these numbers and try to determine if you (the borrower) have the experience to meet those averages.
Most lenders require a down payment for a franchise purchase. It is essentially a way to share the pain and the risk. This down payment can range from 10% of the purchase price to 30% or more with the average being around 20% to 25%.
This means that you have to come to the table with some money and be able to legitimately prove that you have those funds and where they came from (no lender will lend to you, say 80% of the amount needed, knowing that you already borrowed the other 20% – just too easy for the borrower to walk away without any real skin in the game).
Given the current economy and the state of lending to small businesses – especially unproven franchisees (the franchise system is proven, the new owner is not in the eyes of lenders) – collateral requirements are climbing. Thus, what use to take just 30% or 40% in collateral value to back a franchise loan could now take 50% or more.
This means that when seeking franchise loans be willing to either put up the plant and equipment your franchise will be buying with the loan funds or be willing to provide additional collateral like your personal home or other personal assets.
The SBA loves franchises. Not only are these usually proven business models, they come with a huge support and mentor system – items that the SBA think are key to business success.
But, more than that, the SBA offers numerous funding programs for all types of franchises. Some programs are more geared towards franchises that require a lot of property and equipment, some programs are designed for labor intensive franchises, some programs are designed for exporting and international trade businesses / franchises and some are designed for veterans. Plus, the SBA offers working capital funding programs which typically tend to be some of the hardest business loans to acquire given that most new businesses do not have a lot of financial assets to back the loan.
Community Development Loans
Also in conjunction with the SBA’s 504 business loan program, community development loans are great financing vehicles for franchises needing to finance commercial property and equipment (items that can be collateralized).
These programs can also reduce the amount of a down payment that a franchisee will need.
Example: Let’s say that your new franchise needs to purchase $500,000 worth of property and equipment. For a traditional business loan and even some SBA loan programs this means that you would have to come up with a down payment of some $100,000 – which is quite hefty.
But, with community development loans, that amount could be cut in half.
Under these programs, the borrower would provide as little as 10% of the loan amount. The community development corporation would provide 40% and a SBA loan provider would provide the remaining 50% — essentially spreading the risk and reducing the up front outlay of the business owner.
Plus, these community development corporations already work with many SBA approved banks and lenders – not requiring the franchise owner to have to track these resources down.
Retirement funds are usually earmarked for those golden days when one can stop working and really enjoy all they have worked for. Well, owning a franchise can do the same thing by providing a solid financial future to the owner and possibly their heirs.
The goal with retirement investing is to leverage small amounts of current income (monthly or annually) for huge appreciation in the future. You invest $100 per month for thirty years for a total outlay of $36,000 in hopes of growing that sum to half a million or more.
Investing in your own franchise can do the same thing. You leverage your retirement funds today, for future cash flow – cash flow that can be re-deposited back into your retirement fund or used to create your future financial security.
Thus, taking, let’s say $100,000, out of your retirement fund to purchase a franchise today that could turn into 3X, 4X, 5X or sky’s the limit in the future.
Even if you don’t have enough in these accounts to fund the entire franchise purchase, these monies could help satisfy the down payment requirement for you to secure the needed business loan.
To invest your retirement funds into your franchise, you simply create a new C-corporation that will operate the franchise. Then direct your retirement fund to invest in that new C-corporation.
The best part here is that this is not a loan. Thus, no payments and no interest are required.
Home Equity Loans
While these home equity loans are still a bit hard to get as most mortgage lenders are only looking to fund a home’s purchase and not a second or equity loan, they are still out there. And, with interest rates remaining at record lows, can provide a great way to cheaply finance your franchise or at least to come up with your required down payment.
For most franchises these days, finding a single, all inclusive loan is nearly impossible. Thus, most new franchise owners have to find individual business loans for individual needs. When seeking to purchase property and equipment, look to a SBA loan program. When seeking working capital or inventory financing, look to home equity loans. And, when seeking down payments or overall business development, look to those retirement funds.
Franchising is a great way to enter the world of business. They provide tons of benefits with the most important being that they can be up, running and profitable in no time flat.
However, financing that franchise purchase might be another story. While all small business financing is harder to get these days – it is not impossible. You just have to get a bit creative and be willing to take some personal risk – which in the long-run might just be the difference between success and failure. If you have a lot at risk, you just might work a little harder to succeed.