3 Sources of Franchise Financing

Making sense of the current economy and its impact on franchise funding

If you are thinking of becoming a business owner by buying a franchise, you are no doubt wondering if there is financing available in this unsettled economic environment. Financing is a crucial part of the process of becoming a franchisee and what you can afford – or borrow – will determine which businesses you focus your research on.

The current environment in the lending market makes selecting the right resource for your funding very important and yes, there is still financing available for qualified people.

Despite what you hear on the news, money is out there and available because there are institutions (such as insurance companies) who have not been affected by the housing market and have money to lend. But, we are also seeing some changes to that lending process. The first change is that it is more important than ever to start the process of finding financing before you even choose the business you want to buy. Another change is that when you are approved for a loan, you will need to move on it quickly. Lenders are not going to leave credit commitments out there for 30 days or so; they will want you to move in a matter of 5 to 10 days. If you don’t take it, they will lend it to someone else.

Additionally, your credit score may be scrutinized more closely than in the past; you’ll probably need a score at least in the low 700s or sometimes higher.

Here are 3 sources of franchise financing you may want to consider:
1. Traditional lending institutions and SBA-backed loans
Many traditional lending sources have been adversely affected by the home lending situation and therefore have liquidity problems. With home values decreasing, banks are more interested in repayment than they are in collateral. Many will tell you that they own all of the property they want (think of the glut of foreclosed houses). The good news is that franchising as a business model is received very positively in the business market – both by the government and by banks. Banks need to lend money to make money and franchise businesses add jobs to the economy. Therefore, lending institutions that do not have a liquidity problem are willing to loan money for sound business acquisitions such as a franchise purchase.

If you already have a business relationship established at your local bank, this may be a good route to explore for conventional or home equity lending. However, many banks are not familiar with the intricacies of franchising and may avoid working with franchise companies. Your next step may be to work with a company that specializes in facilitating franchise financing (we work closely with two of these companies – Guidant and FranFund). They have relationships with institutions that know franchising and are eager to make these types of loans.

Please keep in mind that lending institutions will require that you pay cash for a part of your business start-up costs which is why most franchises require you to meet both the liquid capital as well as their net worth minimums.

There’s good news if you are coming back from your military stint overseas – the government has established a program called the Patriot Express Pilot Loan Initiative. This is an SBA guaranteed loan program for military veterans or those currently in the military close to retirement (check the SBA website at www.sba.gov for eligibility requirements) or their spouses. The SBA will guarantee up to 85% of the loan, meaning the lender only is at risk for 15%, making these loans very attractive to the lender. And if your credit score isn’t stellar, don’t worry. For Patriot Express loans lenders will often accept credit scores in the 600 range.

Honorably discharged military personnel should also look into the VetFran program which was started by the International Franchise Association as a way to help veterans by offering discounted franchise fees. To date over 300 concepts have joined the program.

2. Borrow from your retirement account
If you have an IRA, 401K or other retirement saving account, you may be able to use that money to help invest in a business. Now don’t panic. I’m not suggesting you cash out your 401K but you may want to consider investing it differently. If buying a franchise will mean the investment outperforms the market, it makes sense to invest in a sound franchise business rather than in a poorly performing stock. If you think of the franchisor’s FDD (Franchise Disclosure Document) as a stock prospectus, focus on Item 19 which details potential earnings. Compare potential earnings from the franchise with the average earnings of a stock and you’ll see what we mean.

By working with a financial advisor you may be able to set up an account that allows you to use retirement funds for investing in a franchise without taking a taxable distribution or incurring penalties. Essentially you are investing in yourself and saving the debt you’d incur by taking out a loan. As your business becomes profitable, your retirement account will also realize gains ─ tax deferred.

3. Cash
Over the past years, a large number of executives have been given the boot, often with a nice severance package to soften the blow. As helpful as a hunk of cash can be when you’ve lost a job, it’s not always enough to make up for years of lost wages. If you’ve received some severance money, or if you have liquid capital available from another source, one use for it would be to fund your own entry into business ownership via franchising.

There are numerous benefits to self-financing. You will not be paying interest on the money. You’d be employing yourself and probably others – a nice benefit to your community. Finally, your investment in a business and in yourself would possibly pay you dividends at a greater rate and in a shorter period of time than if you put the money in CDs or invested in the stock market.

How do you know which finance option is best for you? There are a number of companies who can help you find franchise financing. These companies typically have established relationships with various lenders that specialize in one or more parts of franchise financing. They may offer equipment leasing options, signature credit lines, 401K rollover products, SBA lending, conventional lending, etc. After gathering your financial information, the franchise funding specialists will formulate a lending strategy for you. Then, once you make the final decision to proceed, they will package your information into the preferred format of the lender and follow the process from beginning to end. Their knowledge and relationships in the industry are critical in expediting the transaction.

Because there are many different ways to finance a new business, you should be prepared to do some careful research on the subject to make sure you find the option that will work best for you. Your best source of information may be 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.

Whichever source you choose for your financing, you will need to be very thorough, organized and prepared. Lenders will want to see your loan proposal which includes how and what the loan will be used for and why it is needed. You will need to provide information about yourself, including education, experience and accomplishments. Information about your company’s products and the market you will serve will also be considered. The more research you have done, the better prepared you will be to find financing for your new franchise opportunity.

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Lori Kiser-Block is President of FranChoice, a national network of franchise consultants that provide free guidance and advice to qualified individuals in the United States searching for franchise opportunities that match their personal interests and financial qualifications.