How to Finance a Franchise

Four Parts:Arranging Financing with the FranchisorSecuring Outside FinancingUsing Your Own AssetsRefinancing your Franchise

A franchise is a business for which a person is licensed by a large company to operate under its name. As a franchise licensee, you own a store that is part of a chain of restaurants, gyms, rental car agencies, etc. Starting one of these stores requires a fair amount of money. There are several ways to finance a franchise. In addition to using your savings and leveraging your existing assets, there are loans and grants available from many sources. You may need to utilize more than one of the following methods to raise enough capital to start your business.

Part 1
Arranging Financing with the Franchisor

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    Create a resume. In applying for any kind of loan for your franchise, there are three documents many creditors will want to see. The first of these is a resume that shows you are qualified to run the business you plan to start.[1] Relevant experiences to put in your resume would include:
    • Previous franchises you have run.
    • Experience hiring and training employees.
    • Management experience in businesses in the same (or a similar) sector.
    • Ideally, you want to be able to show three to five years of relevant experience.
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    Calculate your net worth. Another thing most creditors will want to see is that you are able to pay back any loan they give you. The best way to do this is to be able to show a detailed calculation of your net worth.
    • Your net worth is a determined by adding up all your assets (cash, real estate, vehicles, etc.) and subtracting all your debts (credit card, mortgages, loans, etc.).[2]
    • Enter assets and liabilities into separate columns on a balance sheet (e.g. in Excel). Many creditors will be interested in seeing the full balance sheet to get a sense of whether you are financially stable and if you have a good track record of paying your debts.
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    Write a business plan. Third, many creditors will want to see a complete business plan, showing that you have thought carefully about the industry you plan to enter and that you have a plan to make the franchise successful.
    • Your business plan should include an introduction to the franchise’s management structure, a cost analysis for getting the business off the ground, financial projections (i.e. expected profits and losses), and a marketing plan for building business success.[3]
    • Your business plan should also include a detailed technical study of the area of business you plan to go into (which will hopefully demonstrate the demand for the franchise you plan to open in the area you'll be operating), a certified statement of your net worth and several credit references.[4]
    • If you haven't written a business plan before, you may wish to seek help from someone with more experience than you. The US Small Business Administration (SBA) website can also provide further guidance.[5]
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    Find out what financing your franchisor offers. The place most franchise licensees will start looking for financing is with the franchisor company itself. Many offer loans through their own finance companies or third party financiers they have business relationships with. This will often cover a significant portion of your startup costs.[6]
    • Franchisors may also have agreements already set up with companies that can lease you some of the equipment you need to get the franchise up and running.
    • Each franchise has it's own package in terms of what it will offer new franchise licensees. Check into what your company offers.[7]
    • This information may be available online or in other documents provided with your franchise application, or you may need to request it.
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    Look into down-payment and collateral requirements. Franchisors will require you to demonstrate that you have some collateral that will allow them to recoup their money, should your franchise fail. Many also require that you put up a down-payment of money that you have NOT borrowed from other sources.[8]
    • McDonalds, for example, typically requires new franchise licensees to pay 25% of the costs of a franchise out of pocket, in cash.[9] This ensures that franchises only go to people who have the necessary resources to make payments.
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    Apply for financing. Complete the necessary forms to apply for financing from the franchisor. Again, these will vary based on the company. Information about how to apply for financing may be included in the Franchise Disclosure Statement,[10] or you may need to request it from the company.
    • The Franchise Disclosure Statement is a document you will receive from the company if your franchise application is approved. It spells out in minute detail the specifics of the franchise agreement. It is mandated by the Federal Trade Commission that all franchisors provide this document to licensees.[11]
    • Like any other loan application, you will be expected to provide information about your assets, financial history, and net worth.

Part 2
Securing Outside Financing

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    Apply for a bank loan. Another option consider for financing your new franchise is a standard small business loan from a bank. Especially if you have a good credit rating and are opening a franchise with a positive reputation, banks may be willing to offer you some starting capital.[12]
    • Typically bank loans of this sort will require you to put up some kind of collateral, such as your home or any stocks or bonds you might own. They will also often want you to pay for as much as 20% of the cost of starting the franchise from your own money, to be certain you are capable of covering major business costs.
    • These loans usually require you to have already established a relationship with a banker.
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    Apply for an SBA loan. If your bank won't provide you with a loan, you may be able to secure a loan through the US Small Business Administration. These loans are disbursed by banks and credit unions, but are guaranteed against default by the federal government.[13]
    • SBA loan 7(a) is available to franchise licensees opening any business on the SBA's franchise registry.[14]
    • You can borrow between a couple hundred thousand and a few million dollars through the SBA. These loans typically have a five-year maturity period, so they work well for startup costs, but not longer-term expenses.
    • The International Franchise Association provides a directory on their website of vendors that administer SBA loans. The process of applying for an SBA loan, however, is a highly complicated one. Thus, it is usually recommended that applicants secure assistance from an accountant. If you don't have an accountant, your franchisor may be able to suggest someone.[15]
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    Use an online loan portal. A recent development in the world of franchise financing is the online loan portal. These are websites that match franchise licensees with private creditors.[16]
    • Two of the biggest online loan portals are Boefly and Franchise America Finance.
    • Some franchisors have have relationships with these companies. Ask your franchisor if they subscribe to any of these website.[17]
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    Find investors or business partners. Another option for financing is look for a business partner to share the cost (and profits) of your new franchise. Many franchise licensees also turn to friends or family to borrow money or ask them to invest in the business.[18]
    • Several small loans from friends or family members, to whom you promise to pay some mutually agreeable interest rate, can go far to cover the costs of starting a new franchise.
    • You can also advertise in the local press seeking an investor or business partner.
    • Be sure to draw up a formal agreement about the terms of the investment (i.e. how much they are investing, what interest rate you will pay, and over what period you will pay back the loan). This is especially important if you have investors who you don't know well.

Part 3
Using Your Own Assets

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    Use savings and other assets. Most franchise licensees end up covering at least a portion of the startup costs from their own resources. An obvious place to start is with your own cash savings.
    • Don't go overboard on this. A good rule of thumb is not to invest more than 75 percent of your cash reserves. That way, if an unexpected expense comes up, you have some money to cover it.[19]
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    Use your retirement fund. Another common approach to self-financing is to use funds in your retirement account.[20]
    • If you withdraw these funds as cash, you'll lose a significant chunk in taxes. A common way around this is to set up a C Corporation to own your new business. Then, roll your personal retirement funds over into the corporation's profit-sharing plan, and direct that the funds be invested in the new franchise. An accountant can help you set this up.
    • Be warned, however, if your new business fails, your retirement funds will be wiped out.
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    Borrow against your home. Many people starting a new business will borrow money based on the value of their home to get the business started. There are two ways to do this:[21]
    • You can get a line of credit based on the value of your home.
    • You can take out a second mortgage on the house.
    • Be warned that with either of these options, if you find yourself unable to make payments on the money borrowed, you could lose your home.

Part 4
Refinancing your Franchise

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    Decide when to refinance. Refinancing is taking on a new loan which pays off any old loans you already have.[22] Most commonly, this is done to reduce interest payments, but could also be an opportunity to borrow additional funds and consolidate that loan with existing ones. You should consider refinancing if:
    • You can get a loan at a better interest rate.
    • You want to consolidate multiple loans into a single payment.
    • You want to change from and adjustable to fixed rate of interest, or vice versa.
    • You need more capital to update equipment, make improvements, or open an additional location.
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    Look into refinancing options. It is a good idea to frequently look for loans that will offer more favorable terms than the one(s) you already have. This can significantly reduce your interest payments and free up capital for other uses.[23]
    • Once you've been in business for a while, you may become a more attractive customer to banks and other financiers. This is because over time, you demonstrate your ability to successfully run your franchise. This makes you a less risky investment. That, in turn, can lead to offers with better rates.
    • Check with your bank, and re-examine the option of an SBA loan, as this is often the least costly option for people who can get one.[24]
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    Weigh the fees against the savings. Refinancing isn't free. There are usually fees, such as closing costs, involved in refinancing any loan.[25]
    • There may be other penalties as well, based on the details of your old loan.
    • The question to ask is whether the savings outweigh the fees, time, and effort that go into refinancing. You may find that you can refinance and save a thousand dollars over the life of the loan. You'll need to decide if that's worth the time and effort. Your answer might be very different if you could save ten thousand dollars.
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    Update your business plan. Before applying for a new loan, update your business plan to reflect the current state of your business and your goals for the future. Your new business plan should include:[26]
    • Strengths and weaknesses of your business.
    • Major milestones or accomplishments.
    • Expertise you have developed in running the franchise.
    • Goals for the next two to five years.
    • Two years of tax returns.
    • The payment schedule of your current loan.
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    Apply for a new a loan and pay off the old one. Fill out an application for the new loan. When you receive the funds, pay off the old loan.
    • Typically, the bank will handle the payoff for you. They will pay off your old loan, and billing will come from the new loan company from then on.[27]
    • You may be able to refinance with a lender you already have loans from. This can save time and effort and sometimes mean less fees.[28]

Tips

  • Be sure to have any investment agreements reviewed by a legal professional prior to accepting money from investors, especially if they are people you don't know well.

Warnings

  • It is not advisable to invest money set aside for specific important purposes (such as your children's college fund) in your franchise. As confident as you may be in its success, businesses fail every day. If that happens, there will be no way to recover your money.
  • Never use money from new investors to pay previous investors. Doing so could inadvertently turn your legitimate attempt to finance a franchise into an illegal investment scheme.

Sources and Citations

  1. http://fitsmallbusiness.com/franchise-financing/
  2. https://www.entrepreneur.com/article/36480
  3. http://fitsmallbusiness.com/franchise-financing/
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Categories: Funding