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Franchise Funding Options

The attributes inherent in purchasing a franchise often make the search for the start up capital worthwhile. In many cases franchises provide you with the sole opportunity to own and operate your own business because they come as turnkey operations. This not only provides the know-how and support you might otherwise not have, but more importantly, it makes it affordable because the franchisor has already engaged in the costly product development, operations and systems creation, and certain marketing activities that would have put the cost of entry too high if you needed to do it all on your own.
Even with the relative cost savings associated with the purchase of a franchise, there is still often quite a bit of money that needs to be raised to purchase, launch, operate and sustain your new franchised business. Even for those franchises with low initial fees, you need to keep in mind the additional costs of equipment and training, and also the funds you’ll need to keep your business running until the positive cash flow kicks in. The information on how much money you actually need (all these expenditures included) should be included in the Uniform Franchise Offering Circular (UFOC) issued by the franchising company. While these numbers are established based on the experience of the company and are usually close to accurate, Tudog always recommends adding an additional 20% to be certain sufficient capital is on hand.

In all, the sum of capital you’ll need can range from $80,000 to $500,000 depending on the type of business you elect to purchase and the kinds of equipment you’ll need. With this kind of money necessary, the question of the moment is; how can a franchisee raise the capital? The answers lies somewhere among the options presented below:

1. Check Out the Franchisor

In most cases the franchisor will be your best source of information on funding options. The franchisor will not only help you best understand what your actual costs and realistic revenue projections are, it will also give you fair and reasonable assessments of your chances to receive funding from the various capital sources.

Under some circumstances the franchisor may have cut an agreement with selected lenders who have agreed, under certain circumstances and contingent on certain qualifications, to lend money to franchisees. These lenders are often the easiest to get funding from, but are not necessarily the least expensive. Therefore, although you can hold them as an option of last resort, you should explore your other capital opportunities prior to accepting franchisor brokered financing.

Finally, the franchisor may also be offering financing. In many cases the franchisor wants to assist interested parties in getting to the “yes” decision, and do so by offering to finance at least the initial fee portion of the franchise costs. They often do this through “debt financing”, meaning the franchisor carries the “paper” and your franchise owes the principle plus interest to the franchisor. Like franchisor brokered financing, franchisor capital is not always the least expensive, although it is the easiest to attain. Prior to opting for franchisor financing you should explore all your other options.

2. Leasing Companies

Many times, when equipment is needed (such as a restaurant), the franchisor will seek to create an agreement with a leasing firm that leases or finances the equipment under favorable terms. The leasing companies agree to do this because they are assured high volume as most of the franchisees of the particular chain will get their equipment from them (indeed some franchises compel franchisees to get equipment from designated suppliers). Insofar as equipment can be up to 75% of your overall expenses, having an approved source that provides financing can serve to resolve most of your capital issues. The caution here, again, is that the financing offered may not be the least expensive available. Many times the franchisor uses financing as an additional profit center, driving the cost of the lease financing higher than other sources of capital.

3. Home Mortgage

Chances are most of the capital you have is tied up in your home. If so, there is a good possibility that you have untapped equity that you can use to help finance your franchise. In order to exercise this option you would need to take a home equity loan against your house. This should be done only if you are able to afford the failure of your franchise, meaning you will be able to repay the mortgage even if your franchise doesn’t meet your earning expectations. While most franchises do not fail, some do, and your inability to continue to service the loan should your franchise fail will place your home in danger.

4. SBA Loans

The Small Business Administration of the U.S. Department of Commerce makes it easier for banks to give loans to small companies that might not otherwise meet the bank’s lending criteria. The SBA offers guarantees that essentially ensure the bank payment of the loan issued if the approved lender defaults and the collateral is insufficient to cover the entire outstanding debt. The SBA generally supports loans to franchisees because they are view as lower in risk, however they still require collateral. This can be presented in the form of your home, stocks, bonds, insurance policies, pension, or your IRA. With the pledged collateral, the bank can issue the loan, providing you with the funds you require. It should be noted that in many cases SBA loans carry lower rates of interest and that it is wise to explore the SBA option as one of the possible funding choices you consider.

While there are some additional funding options – such as standard bank loans, finance companies, seeking partners or investors, and raising (borrowing) money from friends and family, the above 4 options are usually among the best options. The most important thing to remember when seeking to finance a franchise is that you should only gamble with what you can afford to lose. Do not let the relative certainty of a franchise permit you to rationalize and accept risks you can’t take and under other circumstances would not take. Always keep in mind that some franchises do not succeed and many others do not reach the expected level of revenue.

When borrowing from an institutional lender, like a bank, make sure you choose a lender that understands franchises and is able to view the turnkey operation you are purchasing as a lowered risk factor. In every case, however, make certain that the money you raise is sufficient and that you keep the loan in good standing at all times.

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