Nine ways to finance your franchise opportunity

By Steve Hockett

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:

Franchise Financing Options

  • Cash
  • Home Equity Line of Credit
  • Bank Loan
  • SBA Loan
  • Equity Financing
  • Retirement Accounts
  • Franchisor Financing
  • Partners/Friends/Family
  • Credit Cards

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

Home Equity Line of Credit. The fastest, easiest and cheapest way to borrow money is to set up a home equity line of credit at a bank. This option only works if you have sufficient equity in your home to secure a loan for the amount you need. A home equity loan is generally inexpensive to obtain with fees usually in the $500 – $1,000 range and available at low interest rates. In addition, the after tax benefits (because interest on the mortgage of your primary residence is tax deductible) makes this type of franchise financing very affordable.

Bank Loan. Obtaining a loan from a financial institution is one form of debt financing and is typically referred to as a commercial loan. The usual sources are banks, savings and loans or commercial finance companies. Banks typically require significant levels of 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. Most banks also will require a personal guarantee of the loan, particularly if this is your first bank loan for a business or a franchise.

SBA Loan. 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. Certification by the SBA will add approximately 1-2% of the loan value to the cost of the loan, and this is in addition to fees the bank charges. It can also add a few weeks to the approval process. 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 franchised business in exchange for capital. Investors may be friends, relatives or employees or they may be professional investors, generally known as Venture Capitalists. Attracting venture capitalists to help you purchase a franchise may be difficult however as they are usually more interested in franchisor operated companies with great potential and a history of success, rather than a single unit/multi-unit/territory based start-up franchisee operated 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 franchise. By working with a financial advisor specializing in this type of conversion, 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.

Franchisor Financing. There are a few franchisors who work directly with financial companies to provide financing packages for new and existing franchisees, often at low interest rates. If this financing is available it may be a good option provided you can qualify.

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 franchised 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.

Credit Cards. Because of high interest rates and low credit limits, credit cards are usually not the best place to look for money when financing a franchise. It may take many months before your new business is making money and the last thing you want to do is hurt your credit rating by borrowing money you can’t easily repay. Plus, the monthly finance charge can add significant costs to your overall investment. A better use for your credit cards would be to save them for emergencies.

This brings us to a critical point – your credit history. Lenders of any type will want to see a strong credit history including a track record of your borrowing money and making payments on time. You must demonstrate your commitment to the success of the business and show that you have sufficient cash flow to make monthly payments.

The best plan when getting financing for your new business is to be 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.