Financing a Franchise

Many prospective franchisees will need to finance part or all of their purchase of a new franchised business. Traditional lending sources are available but the restrictions related to financing any new business startup, even including a franchised business, are stringent. Click here to view a list of financing options.

The best source of information about financing options for any franchise is the franchisor. This is an issue that the franchisor has addressed numerous times with other franchisees and they will have a good deal of information about the practical options that are available.

It is not easy to borrow money to start a new business, but it can be done. It is important to understand the requirements and needs of the lendor and to be realistic about what can be accomplished. A lendor is looking for factors that will reduce the risk associated with the loan and the more you can offer in this area, the easier it will be to get your loan.

In general, the lendor is looking at four factors: Character, Credit, Cash, and Collateral. If you don't have a good reputation and a good credit history, you're almost certainly not going to obtain a loan for a new business startup. The lendor also wants to see that you have a significant amount of your own money invested in any business before they will make a loan (typically at least 25-30% of the total investment, including working capital).

The most important thing that a lendor wants to see is collateral to secure the loan. This may be provided by the tangible assets of the business itself, but lendors commonly look to the personal assets of the borrower to provide most if not all of the required collateral. This means that you will need to have a net worth in real property, in most cases, equal to or greater than the total investment in the business in order to obtain a loan.

One of the great advantages of franchised businesses is that a good franchise will have established a track record of success with new franchisees entering the business. In many cases, the franchisor is able to leverage this track record to set up semi-automatic financing programs for new franchisees. These can be either leases or loans that are provided primarily because of the success of the franchise system rather than relying on the credit worthiness of the borrower.

A program like this can make the financing issue an easy one to deal with for the right franchise. Information on the existence of such programs can be obtained from the franchisor during the course of an investigation of the franchise.

Have No Money?

If you find yourself in the position of not having enough resources, the following four-step strategy is designed for you.

The Partner Option
The first step is to ask yourself if you know someone, a friend, relative or acquaintance, that would potentially be willing to back you with the resources needed to start a business. If you think of someone that is a possibility, discuss this idea with them and determine the circumstances under which they would be willing to participate and the amount of resources they might be willing to invest.

This option will enable you to pursue a franchise opportunity without waiting since you can then add their assets to your own in order to meet the minimum standards necessary to pursue the business. The disadvantage is that the partner will usually own part or even the majority of the resulting business since they put up the money.

The Borrowing Option
Many people who do not have the necessary resources themselves are willing to borrow the money to get into business. The only drawback with this strategy is finding some entity willing to lend the money. There's a lot of truth to the old adage that banks will only loan money to people who don't need it.

The reality of borrowing money for a new business startup, even a franchise business with a strong proven track record of success, is that lending institutions want to see collateral (independent of the assets of the business) for every dollar borrowed. They also want to see a substantial cash investment on your part into the business, usually at least 25% of the total.

The Small Business Administration (SBA) is not a lending source and will not help you get around these requirements. All the SBA does is guarantee loans, in exchange for a fee from you, for those people who still can't borrow money even when they have the necessary collateral.

The one other advantage of some of the strongest franchise companies is that they will have made arrangements with lenders that facilitate loans to their franchisees. In some cases these loans are virtually automatic assuming you have a clean credit record and the necessary down payment. This can be a huge advantage for the franchisee.

The Savings Option
The third option available to you is the surest method for most people, though it will take discipline and patience to succeed. The key is to build your net worth and asset base so that you have something you can leverage in the future. If you don't have the funds necessary to purchase a franchise, but are very interested in someday doing so, you need to start preparing today by saving everything you can.

Go down to your bank and set up a "business ownership" account. The secret to this account is that you won't touch whatever funds you put into it until you're ready to invest in a business of your own. Start the account with all the funds that you currently have available. Next, put a fixed amount of at least $500 into this account from each monthly paycheck (direct deposit would be best). Never miss a deposit.

This may seem like a slow road to travel but it serves two purposes. First, you'll be surprised at how fast the money will grow. Second, it gives you a key piece that you need to begin working with bankers and franchisors to put financing options together.

To get financing, you must have equity, credit or credibility. The first two are obviously missing or you wouldn't be reading this section. Assuming this is true, the third is the easiest to get. After as little as six months or a year of following the savings plan as outlined above, you will have established a track record that shows you are serious about owning a franchise.

At this point you can contact franchisors directly or use a consulting service provided by FranChoice to see what options exist for you. Even if you find that you'll have to keep saving for another few months or longer, you'll still be on your way to making your dream of owning your own business come true!

The Retirement Plan Option
Unfortunately, many entrepreneurs will take a taxable distribution from their retirement plan in order to come up with the necessary capital to purchase a franchise. There is, however, another way to use your retirement funds to finance a franchise. This funding solution, which is performed by a handful of experienced and qualified professional organizations across the country, is a combination of a retirement plan and a corporation. In using this structure, your retirement account would invest directly into a new franchise opportunity, providing the necessary capital to purchase, open and operate the franchise of your dreams. Your retirement account actually takes ownership by purchasing stock in the corporation - it's much like if your IRA were to purchase shares in a publicly traded company. Similarly, as your franchise becomes profitable, your retirement account will also realize gains that are tax deferred.

Determining how you will finance a new franchise purchase is one of the most critical choices you have as a new owner. This financing tool would allow you to purchase a franchise without applying for or obtaining a loan - keeping your overhead low and allowing your franchise to prosper at a higher level. This can be a very cost effective and expeditious way to reduce or eliminate any debt service, redirect your retirement funds into a less volatile environment than the stock market and potentially defer upwards of $40,000 per year back into your retirement plan. These kinds of transactions are outlined specifically in the Employee Retirement Income Security Act of 1974 (ERISA) and, when performed by a reputable organization, come with an IRS determination letter.