Financing the Franchise
Perhaps the most difficult part of getting into franchising is affording the one of your choice. Starting a franchise is expensive; in many cases you’ll have to pay for construction, land, leasehold improvements, inventory, equipment, signage, decoration, and the various fees owed to the franchisor for use of the business name, concept, and territory. There are also ongoing fees that will form a part of your monthly expenses. The expense may seem daunting, but it is merely another challenge, like all the others that come before in the franchise process, and all those that will come in the future. As a potential franchisee, it is useful to understand those options available to you as sources of funding for your investment. This article will introduce you to the most common sources available to you, as well as some not so common ones, in an effort to help you find how you can best finance your business.
1. Cash: Cold and Hard, Ready and Able
The first place to look for funding is your own personal cash reserves or other easy to liquidate assets such as stocks, bonds, etc… It may seem obvious, but the only funding you can be sure to find is your own. Most loans will require you to invest a portion of your own funds, so sooner or later it comes down to cash. If you don’t have any personal savings, or your savings is small, you should begin saving more money the moment you begin seriously thinking about owning a franchise (though it’s a good idea to save anyway). The key to saving and to wealth building in general is high income, low expenses. If your income isn’t high enough for you to comfortably save, then you may be living above your means. See how you can cut expenses in your daily life. Even simple things like carpooling to work or dining out less frequently can add hundreds of dollars of savings a month. If you do have the requisite cash to finance the franchise yourself, you still may want to look into other options to spread out your payments and to keep some personal savings for emergencies.
2. Debt Financing
Debt financing involves using borrowed money to finance business expenditures. This is money that you will be required to pay back over time with interest. Most loans will require some sort of collateral, regardless of the business entity, to ensure that there is some way for the lender to recoup a loss in the event that you default on your payments. Collateral also provides incentive for you to work hard to protect the investment. A loan requiring collateral is known as a secured loan. For the most part, lenders like to see a strong credit history and if possible, previous evidence of borrowing money and making timely payments. There are a few different ways to obtain debt financing, each with their respective benefits and detriments.
a. Line of Credit
A line of credit is the ability to borrow money as you need it. A bank may give you a line of credit for $10,000 meaning that you have $10,000 available to draw from, like you would on a credit card. Also like a credit card, you are not liable for any amount that you do not choose to borrow. This kind of debt financing is ideal because you can incur debt for exactly as much as you need, instead of paying for all of it even if some of it remains unused. Usually, the limit to the size of a line of credit is smaller than for other types of debt financing and may be much harder to obtain.
b. Business Loan
In this scenario, a bank will grant an amount of money for use on the business, for which you will have to pay interest and monthly payments of the principal (the principal is the borrowed money on which interest is calculated). Lending institutions often have stringent requirements for those that wish to borrow, including strict collateral and equity requirements. Bank loans are usually needed for large sums of money although you will not have the same flexibility as a line of credit.
c. SBA Loan
The Small Business Administration (SBA) is a federal agency that helps stimulate small business by acting as a guarantor for loans with approved banks. To apply, visit an SBA approved bank. With the help of the SBA, turnaround time is increased, interest rates are reduced, and repayment time is increased as SBA guarantees make the loans safer for banks. SBA loans, however, limit the size and purpose of the loan depending on the program chosen. Usually, an SBA loan can only be used for expansion of a business, purchase of a new business, or the restructuring of previous debt that was financed on unreasonable terms. Here are some specific programs offered by the SBA:
- The CDC 504 loan program only allows the use of funds for purchasing buildings, machinery, or land.
- The SBA 7(a) loan program allows the user to finance buildings, machinery, land, equipment, inventory, and working capital.
- The SBAExpress program is a special expedited loan program open only to certain prequalified businesses. Many franchises belong to this category.
As the name suggests, potential SBA loan recipients must qualify as a small business according to federal regulations. And like all loans, there will be a need for collateral and a personal guarantee for portions of the loan not covered by the SBA. Visit http://sba.gov/ for more information.
d. Franchise Financing
It is a good idea to consult with your franchisor while looking for funding regardless of your situation. But franchises can be especially useful when looking for financing because they may have programs in place to help fund you in the event that you need financial help. Franchises will differ on how they help their franchisees, but at the least, they may be able to help you apply to other institutions for funding or use their weight to push for better terms on your behalf. Franchises must disclose their financing options in the UFOC, but even if the UFOC states that they do not finance, it can’t hurt to ask them about it also. They may provide help unofficially.
e. Personal Loan
Banks can offer personal loans that cannot be used for business purposes, but can be used to pay personal living expenses. Although the funds cannot be used for business needs directly, it can be used to pay bills and other expenses associated with your cost of living which can free up other funds for use toward the business.
f. Private Loan
A private loan is a loan that is not set up with a regulated financial institution. Private loans are contracts drawn up between yourself and a lender that is a private citizen such as a family member, work associate, or friend. You may want to try to set up a private loan as part of your financing. You may be able to get less stringent terms than a bank due to the fact that banks must be extra careful with the money of their customers. You should still be careful to have any contract you sign reviewed by a lawyer within the appropriate field of study.
g. Credit Cards
Credit cards represent an unsecured loan, meaning that no collateral is required. Credit cards are not useful for payment in all applications of business, but they can be used to make what payments and purchases you are able, to save your cash for aspects that won’t take credit. Additionally, the cash advance option on a credit card can also be employed for emergencies. Credit cards are usually not a preferred method of funding because the limits tend to be low and the interest payments and finance charges can be extremely high. However, it is worth considering their use for special situations.
3. Equity Financing
Equity financing deals with trading an equity, or ownership, share of the business in exchange for capital resources. The terms of the arrangement will depend on the business, the amount of invested capital, and the other particulars of the situation. The equity share requires that the investor own at least a percentage of the profits of your business. Equity financing differs greatly from debt financing in that with equity financing, you are not liable to repay any of the received capital. The investor has no right to claim their funds back, even if the business fails completely. You can’t be held personally liable, and there are no interest payments. However, unlike debt financing, you must continually pay a portion of your profit to the equity holders in your business. With debt financing, your profit is your own. With equity financing, your profit does not belong entirely to you. Like all financing options, equity financing must considered carefully in all its details before a decision is made. If you have poor credit or you can’t afford debt financing, equity financing may be the only option for you. There are at least two important kinds of equity financing.
a. Venture Capital
Venture capitalists are investors that specialize in funding promising new businesses or business expansions. However, venture capitalists do not want to loan you money. They want a share of your business. How much of a share will depend on your business and on how much money they are willing to give. In some cases, venture capitalists may want a controlling or operating stake in your business where they will be a party to the decision-making process. Venture capitalists will usually only fund businesses with a very high potential for growth and reward. As a result, they are unlikely to fund a franchisee.
Partnerships can vary a great deal depending on how the specific arrangement is set up. Usually, a partnership implies joint ownership and management of a business. It may be useful to get a partner to help split the responsibilities, workload, and costs. But you must also split the decision-making, profits, and rewards. Partnerships can be a very good idea or a very bad idea. It’s important to choose the right partner, someone you can work well with but who will also differ enough to compliment your qualities as a business owner. Choosing the wrong partner can quickly become a disaster.
c. Stock Holders
Stock holders are like partners in some respect, in that they are part owners of your business. If you use a corporation or LLC as your business entity, then you can raise large sums of money by selling shares of your company. Managing stock holder concerns and responsibilities can become a difficult task however. There are also a multitude of forms that stock in any company can take. To name a few, there is common stock, preferred stock, senior notes, and convertible bonds. Each have advantages and disadvantages to the investor as well as the to the business founder.
4. Retirement Funding
Depending on the type of business and the type of retirement account, it may be possible to use your retirement funds to partially fund your business while avoiding the usual taxes and penalties associated with early withdrawal of such funds. A Rollover Equity Investment Plan, for example, will allow your retirement funds to be used for the purchase of stock in your corporation, should you found a corporation to manage business assets and liabilities. You should consult with a lawyer and accountant to see what options are available to you for using your retirement funds to invest in your business.
Money, Money, Everywhere
There are many options when it comes to financing, but each has its price. Even using all cash may cause problems if you have none left over for emergencies. The process of finding and applying for funding is long and difficult, but you should not let its difficulty get in the way of your goals. You will need to get all of your information in order, such as personal information, work experience, personal finances, information about the business, resume, business plan, family situation, budget, and so on. As always, the help of a lawyer and/or accountant would be invaluable. You have many choices to consider carefully, and with a little patience and perseverance, you will prevail.