Traditionally, the first place franchisees turn for financing is the franchisor. Almost all U.S. franchisors provide debt financing only. Some carry the entire loan or a fraction thereof through their own finance company. We found fractions of 15 percent, 20 percent and 25 percent, all the way up to 75 percent of the total debt burden. The franchisors we talked to emphasized that these figures are simply guidelines and not hard and fast limits.
In addition, the loans made by the franchisor can be structured a number of ways. Some offer loans based on simple interest, no principal, and a balloon payment that’s due five or 10 years down the road. Others offer loans with no payment due until after the first year.
Instead of financing the entire start-up cost, franchisors may offer financing for portions of the entire cost. They may have financing plans for equipment, the franchise fee, operational costs or any combination thereof.
In addition to financing a portion of the start-up cost, the franchisor usually has made arrangements with leasing companies to lease the franchisee the equipment necessary to run the franchise. This can be a significant part of the financing, since equipment often makes up between 25 and 75 percent of a franchise’s total start-up costs.
If the franchise you’re considering doesn’t offer equipment leasing, look into non-franchise, nonbank companies that specialize in equipment leasing for franchises. These types of financing companies will often provide asset-based lending to finance franchisees’ furniture, equipment, signs and fixtures, and will allow franchisees to purchase the equipment at the end of the lease. Keep in mind that you may lose some tax advantages under the current law if you lease that equipment.
Remember that a business is franchised for two reasons: to expand the business and to raise capital. So if you have a reasonably good credit record and pass all the financial requirements, most franchisors will bend over backwards to get you on the team. The help that franchisors provide to help you get financing usually includes assistance with business plans and introductions to lending sources. In many cases, franchisors serve as guarantors of loans you take out.
OTHER SOURCES OF FINANCING
After you’ve determined the extent of financing available from the franchisor, make a working list of all other available sources of capital. Most sharp operators use the following sequence of contacts: friends and relatives, home mortgages, veterans’ loans, bank loans, SBA loans and finance companies.
Often, banks that aren’t willing to work with you based on your financial profile become more amenable if you suggest working with an SBA loan guarantee; these loans are guaranteed up to 90 percent by the SBA. Small businesses simply submit a loan application to the lender for initial review, and if the lender finds the application acceptable, it forwards the application and its credit analysis to the nearest SBA office. After SBA approval, the lender closes the loan and disburses the funds; the borrower makes loan payments to the lender.
Some franchisors report being approached by financial brokers–historically more interested in big deals–to put together large pools of money using SBA and private funds. These funds would be available to franchisees through the franchisors like a trust fund. Groups of smaller banks with funds to invest would contribute to the fund from all over the country.
Other options would be to take out a home-equity line of credit or a second mortgage on your home. Be careful when utilizing this type of financing, however. The home-equity line of credit and a second mortgage are secured by your home. If you can’t repay the amount you finance using this source, you risk losing your home.
You can also use assets such as stocks, bonds, and mutual funds to secure a loan as long as they’re not part of a qualified plan like an IRA profit-sharing plan. Also, if you are over age 59 and have a lot of money tied up in an IRA, you could use it for part of your financing requirements. Although you’ll have to pay taxes on the amount used, not to mention suffer the loss of income from interest, it can be a good financing tool.
If you are under age 59 and your IRA is one of your largest assets, you still may be able to take advantage of this avenue without accruing the 10-percent penalty associated with early withdrawal. By taking Substantial Equal Periodic Payments spread over a minimum of five years, based on your life expectancy, and a set of annuity tables published by the IRS, you can eliminate the 10-percent penalty, although the money is still taxable.
A GOOD RULE OF THUMB
There are infinite sources of financing available to help you launch the franchise of your dreams. However, operating a franchise with no reserves and blinding yourself to unexpected business problems can lead to disaster. A good rule to remember: Never invest more than 75 percent of your cash reserves. If you have $10,000, invest $7,500. If you have $25,000, invest $18,750.
More important, remember that the price of a franchise doesn’t always reflect the actual cost of the business itself. Additional costs can include down payments on the land, building, equipment, fixtures and signs, and can cover inventory, leasehold improvements, training, opening promotional costs, administrative costs and even sales commissions.
Be sure you understand the requirements of your cash investment. You will need a “pillow” of working capital to properly guide the business through its ups and downs. If you do your homework thoroughly, and remember that financing a business is the most important sale you’ll ever make, then you’ll be head and shoulders above the competition.
15 FRANCHISE TIPS TO FOLLOW:
1. Talk to your franchisor or Franchise Placement Specialist before searching for outside financing; get approved or pre-qualified.
2. The most common source of start-up capital is friends and family. Use them.
3. Seek out lenders that understand not just small business but franchising as well.
4. Be totally honest and upfront with lenders. Hide nothing. Be prepared to explain everything.
5. Neatness counts. Fill out your credit and loan applications clearly. Typed is better.
6. Don’t weigh down your loan application with attached documents.
7. Don’t exhaust your liquidity by paying off outstanding debts before filing a loan application. Lenders want you to have capital available.
8. If you lack liquidity, find a partner with money.
9. Consider equipment leasing to conserve start-up capital and improve the appearance of your balance sheet.
10. Keep debts and expenses to a minimum. Many business owners take on too much debt, forgetting that cash flow must pay that debt.
11. Consider buying used equipment, furniture, vehicles, etc.
12. Let your fingers do the walking on the Internet before wasting time, energy, gas and phone calls. You’ll find useful information. Some sites even allow you to file loan applications online.
13. Don’t overlook angel investors and venture capitalists.
14. Be careful about dipping into your retirement money or your kids’ college funds. Any startup-even a franchise-is a risk.
15. Don’t give up BE PERSISTENT . It pays off!
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