Franchise Buying Guide

Franchise Financing

Because there are many different ways to finance a new business, you should be prepared to do some thorough research on the subject to make sure you find the option that will work best for you. Your best source of information is most likely the franchisor you are interested in joining as they should be familiar with the costs and they will understand the likelihood of you obtaining financing from any particular source.

Some possibilities for financing a franchise include:

Cash. If you have all the money you need in liquid or semi-liquid assets (cash, stocks, home equity, etc.) to start a business as well as run it to the break-even point, you could self-finance the purchase. You should be sure to weight the "opportunity cost" of tying up your capital and compare that to the "hard cost" of another type of financing.

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. The key is to build your net worth and asset base so that you have something you can leverage in the future.

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.

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!

Bank Loan. The easiest way to borrow money is to set up a line of credit at a bank. This option only works if you have sufficient personal collateral to secure a loan for the amount you need and this collateral is usually in the form of home equity. Banks require collateral on most loans because they will want recovery if you default on the loan - and this is true whether your business is a corporation or any other type of entity. Besides giving banks a way to recoup a loss, when you have personal collateral on the line it gives the bank some assurance that you will work hard to protect your own investment as well as theirs.

A loan from a financial institution is called Debt Financing. The usual sources are banks, savings and loans or commercial finance companies. Another great resource is to access the programs available through the U.S. Small Business Administration (SBA). You should make yourself familiar with the SBA's Web site (www.sba.gov/) as it has information on financing options and also explains how to write a loan proposal. If you do decide to borrow money, remember that lending institutions will require that you pay cash for a part of your business start-up costs - usually 25 to 50 percent.

Recognizing that small businesses are an important part of our economy, the government has established through the SBA, its own loan program, the Small Business Investment Company Program (SBIC). The SBA does not make the loans but is primarily a guarantor of loans made by private and other institutions. You can find out more about the loans programs offered by the SBA at http://www.sba.gov/financing/sbaloan/snapshot.html.

Equity Financing. Equity financing requires that you sell someone an ownership interest in your business in exchange for capital. Investors may be friends, relatives or employees or they may professional investors, generally knows as Venture Capitalists. Attracting venture capitalists to help you purchase a franchise may be difficult, however, as they are usually more interested in companies with great potential rather than a single unit/multi-unit/territory based start-up franchise company.

Retirement Accounts. If you have an IRA or other retirement saving account, you may be able to use that money to help invest in a business. 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 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 significant amounts of money 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.

Franchisor Financing. 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.

Partners, Friends and Relatives. If your friends and relatives have confidence in your entrepreneurial abilities they may be willing to loan you money as you begin your business venture. Private loans are often provided at a low interest rate which can be helpful as you get started. You may also want to look for a partner to help you finance and run a business. This is may be a good idea if you are lacking some business skills or experience. We've seen great results when partners compliment each other, for example when one is a dynamic cold caller and the other can handle the employees and customer service aspects.

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