Options for financing the purchase of a franchise are as varied as the franchise opportunities themselves. Your timeline, risk tolerance, credit history, and other factors will determine the best option for you. Let’s take a look at a few common sources of franchise financing.
Small business / franchise financing options
Franchise financing sources include:
- Home equity line of credit
- Bank loan
- SBA loan
- Equity financing
- Retirement accounts
- Franchisor financing
- Credit cards
Saving and using cash
Do you have sufficient liquid or semi-liquid assets (e.g., cash, stocks, home equity, etc.) to run your business until you break even? If so, consider self-financing the purchase. Make sure to compare the “opportunity cost” of tying up your capital with the “hard cost” of accessing another type of financing instead.
If you don’t have adequate funding but hope to have it in the future, start preparing today. Maximize your savings and build your net worth and asset base. Set up a “business ownership” account at your bank. Then commit yourself to depositing a fixed amount of at least $500 into this account from each monthly paycheck. You can even set up a direct deposit to ensure consistency and remove the temptation to skip a deposit now and then. Most important, don’t touch any of these funds until you’re ready to invest in a business of your own.
You’ll be surprised at how quickly the money will grow. And your commitment will show potential funding sources that you’re serious about owning a franchise. After as little as six months to one year of following this savings plan, you will have a nice nest egg. Then you can check with franchisors directly or contact a FranChoice consultant to explore your financing options.
Bank and Small Business Administration (SBA) loans
The easiest way to borrow money is to establish a line of credit at a bank. You’ll need to have sufficient personal collateral, usually equity in your home, to secure a loan for the purchase of a business. Collateral enables the bank to recoup their loss if you default on the loan. Putting your personal collateral on the line also shows the bank that you’ll work hard to protect your own investment and theirs.
Banks, savings and loans, and commercial finance companies are all potential lending sources. Loans from these sources are called debt equity. The U.S. Small Business Administration (SBA) also provides funding options. Its website provides information as well as advice on how to write a loan proposal. If you decide to borrow money, keep in mind that the lender will require you to pay cash for a part of your business start-up costs (usually 25-50%).
The Small Business Investment Company Program (SBIC) is one of many financial assistance programs available through the SBA. “SBICs” are privately owned and managed investment funds, licensed and regulated by the SBA. SBICs use their own capital plus funds borrowed with an SBA guarantee to make equity and debt investments in qualifying small businesses.
Equity financing involves selling an ownership interest in your business in exchange for capital. Investors may be friends, relatives, or employees. Or, you can pursue what’s known as “venture capital” from a professional investor. Attracting venture capital for the purchase of a franchise may be challenging, however. Venture capitalists tend to favor companies that have earning potential exceeding that of a typical franchise unit.
You may be able to access funds from your IRA, 401k, or other retirement savings account to invest in a business. Known as a “Rollover as Business Startups,” or ROBS, this funding structure is similar to buying stock in a public company, except you’re investing in your own privately held company. Your retirement account invests directly in your new franchise and takes ownership by purchasing stock in the corporation. There are no early withdrawal penalties or upfront taxes. And the percentage of profits corresponding to your retirement account’s ownership can be redeposited. This franchise financing method is very specialized, so it’s important to consult an experienced professional.
One of the great advantages of franchised businesses is their track record. In many cases, the franchisor leverages this track record to set up financing programs for new franchisees. They can be leases or loans and are awarded primarily due to the success of the franchise system rather than the creditworthiness of the individual borrower. If you’re interested in this option, gather information from the franchisor during your research and investigation.
Partners, friends, and relatives
Friends and relatives who have confidence in your entrepreneurial abilities may be willing to loan you money as you begin your business venture. You may also want to look for a partner to help you finance and run the business, especially if you lack business skills or experience. We’ve seen great results when partners complement each other, for example, when one is a dynamic cold caller and the other excels at handling the employee and customer service aspects.
Determining franchise financing is one of the most critical choices you’ll have as a new owner. It’s wise to throughly investigate your options and consult with appropriate professionals. Don’t forget that your franchisor is a great resource for information.