So you decided to buy a franchise. Now what?
Whenever I talk with my clients, financing the purchase of their franchises is almost always a major consideration. It’s natural to want to put some resources into your business right away. But before you put down any money, it’s important to do your research. Reach out to fellow franchisees to find out what their expenses were, how long it was before they started seeing cash flow, and how they went about financing their businesses.
Here’s a quick review of the most popular ways businesses get financed:
The first, and most obvious, option is to look at your savings. If you have mutual funds, bonds, and stock market investments, you can liquidate them and apply the money toward your franchise. (Just keep in mind that you will incur taxes.) Many people feel secure investing in their own abilities — which they can control — rather than relying on the unpredictability and lack of control inherent in the markets.
If your portfolio exceeds the amount of money you need, you can borrow against your securities. Interest rates are good, and you simply pay yourself back when you can. If the amount of money you need to fund your business is half (or less than half) of the value of your securities, this is a good route to go.
Using some of your savings to help fund your franchise is always ideal; in fact, lenders will always require you to use at least some of your own dollars. But when it comes to fully funding your business from your own personal assets, keep in mind that experts recommend you never invest more than 75 percent of your cash reserves. For example, if you have $100,000 in savings, invest no more than $75,000 of that in your franchise.
Rollovers as Business Startups (ROBS)
You can also invest your retirement funds in your business. In fact, over the past few years, this has become one of the most popular ways to finance franchises, and there are specialized financial companies that will help you do so. This can be a very attractive option if you think your business will grow in value, and that you may want to sell it in the future. The retirement account will own the business, and when you sell, the bulk of the capital gains will be sheltered inside the account. Best of all, ROBS allow you to access your retirement funds without incurring taxes — regardless of your age. Plus, this option allows you to start your new business completely debt free — you don’t have to pay back the money you withdrew unless you want to replenish your retirement savings. This account is now your business retirement plan, which you can choose to fund or not going forward.
Bank and Credit Union Loans
If using your savings to fund your business isn’t the best choice for you, another option is to get a loan from your bank or credit union.
According to The Wall Street Journal, “Commercial banks fund many franchises, so look to these lenders first. The single most important issue in landing bank financing is your credit rating. You will need to present a complete loan package including a personal financial statement, copies of personal tax returns for three years, and verification of the source of your down payment.”
Keep in mind that your franchise choice will have an influence on whether or not you will receive a loan. Franchises with hundreds of locations and successful track records are going to be the most attractive to banks. An emerging brand that started only a year ago will be much more challenging to find financing for.
When meeting with a bank or credit union, be prepared to provide three years’ worth of tax returns and personal financial statements. You should also be prepared to be asked to put in your own money. The lenders usually ask for anywhere from 20 to 30 percent of the amount needed so that you have “skin in the game.”
Small Business Administration (SBA) Loans
Another great option is to get a loan backed by the U.S. Small Business Administration (SBA). One reason SBA loans are so appealing is because they are partially guaranteed by the government, which makes them less risky to lenders. These loans provide short-term capital (typically seven or 10-year terms) that can cover your franchise fee, equipment, lease build out and working capital. Generally speaking, the total of the highest end of the range in “Item 7: Estimated Initial Investment” of the franchise disclosure document, is the total amount of a loan you will be considered for. These loans carry different interest rates, but are usually 2.75 percent over prime and will require you to inject anywhere from 20 to 30 percent of the loan in cash.
Unsecured Lines of Credit
No discussion of funding would be complete without talking about unsecured lines of business credit. A non-traditional line of credit in the form of business credit cards is among the easiest lines of credit you can get. It will provide fast access to cash, as well as the payment flexibility typically associated with a traditional credit line, but without all the drawbacks.
Qualifying for this type of revolving credit line is FICO-driven and doesn’t require the yearly reviews, excessive documentation, and level of scrutiny that comes with a traditional credit line.
Some of the advantages of non-traditional business lines of credit are as follows:
- Access to cash quickly
With unsecured business credit cards, you can utilize as much or as little credit from your line as you want to, anytime and anywhere.
- High credit limits
Business credit cards carry high credit limits, making it extremely convenient to finance larger purchases. Many cards even offer 0 percent APR for the first 12 months.
With business credit cards, you have flexible payment options, compared to fixed month-to-month payments that come with business loans. When you tap into your credit line, you have three options every month. You can pay the full amount due, pay at least a minimal portion of the balance, or pay greater than the minimum amount due.
- True separation
Business credit cards enable business owners to separate personal and business expenses, while benefiting from business credit reporting. This makes it possible for business owners to establish the creditworthiness of the company itself.
- Personal credit protection
Small business credit cards that report solely to the business credit agencies allow business owners to protect their personal credit ratings while building their credit.
Of course, the rates fluctuate and you can get into trouble quickly. It’s important to manage your debt responsibly, make large payments when you can, and get those credit card debts paid off first. We generally recommend using SBA loans as your primary source of funding, while lining up unsecured lines of credit as a supplemental form of insurance so you can be well capitalized for those first few months when cash flow is minimal.
The options discussed in this article are some of the more traditional methods of funding your franchise, but they’re not the only options. Don’t be afraid to explore other alternatives. For example, many businesses have been financed by friends and relatives. You can also consider home equity lines of credit: They are cheap and allow you to tap into the built up equity in your home with very little paperwork and fees — generally, all you need is an appraisal. No matter what route you take for securing financing, make sure to put together a business plan, do your due diligence, and remember that all things are possible.
Jane Stein is a member of the DailyWorth Connect program. Read more about the program here.