There are many ways to fund a franchise. Using cash is the easiest and most straightforward option, but if you have no other liquidity, that is a bad move. Burdening yourself with an unneeded or incorrectly structured loan can also wreak havoc on your business plan.
We noticed five major mistakes that some franchise candidates make that you should avoid at all costs. The consultants at HIRE YOURSELF realize that you want to save money where you can, but if you try to save on funding you will find yourself tripping over dollars to save pennies.
Franchise Funding Options
There are several funding options for you to pursue when starting as a franchisee. Each has its own set of advantages and disadvantages. It is best to explore all avenues of funding before making a decision and you may find that it is best to combine several different funding choices instead of just going with a single option.
Franchise Funding Option 1: Traditional Loan
This is exactly what you would think it would be: a traditional loan from a bank that is not aimed at a specialty or niche customer. Getting this type of loan will depend on the bank's loaning requirements. This is one of the least popular franchise business loans.
Franchise Funding Option 2: Small Business Association Loan (SBA)
SBA loans for franchises are popular. This loan is often used to fund a first (and often second) location. Banks use this loan because it is backed by the Small Business Association for up to 80% of the principal, which provides great security on their return.
Lenders further prefer this loan for new businesses because the backing from the SBA means they can offer more favorable terms to the lendee. Typically the first and second locations of a franchise location will need to use an SBA loan to build a track record with a lender.
Your business will need to qualify for this loan based on standards set by the SBA. The advantage of choosing to start a business with a franchisor is most of the preparation work for this will already be done. They can help provide you with everything you need to get the correct loan; no need to reinvent the wheel.
Using a lender that specializes in franchises will also help since they have the experience to make sure you meet all the requirements set by the lender and the SBA.
There are several types of SBA loans. SBA Express loans aren't any faster but are used for businesses without much construction costs. They have lower lending limits and due to no or minimal construction requirements, are generally available more quickly than 7A Loans. These loans are better for brick-and-mortar businesses since the loan amount is higher to cover the costs of construction and equipment.
Need to Learn More About Funding a Business? Read This Book
Franchise Funding Option 3: Roll Over for Business Startup (ROBS)
This is an IRS program that allows a franchisee to access their retirement savings to invest directly into a small business. There are no income tax or early withdrawal penalties when using the ROBS program. Think of it as investing in stock in your franchise location instead of Google, Amazon, or mutual funds.
Franchise Funding Option 4: Home Equity Loan
Another option for franchise candidates who own their homes is to take out a home equity loan to finance their new venture. With any home equity loan, lenders will have different rates and it is important to shop around and understand the financial consequences of this decision.
Franchise Funding Option 5: Line on Brokerage Account
Anyone with $180,000 and above in investments may be eligible to take out a line on their brokerage account to fund their franchise location. The higher the existing investment amount is, the easier this avenue will be to use to fund a franchise unit.
Five Common Franchise Funding Mistakes to Avoid
1. Undercapitalizing
When you investigate franchises the franchisor will provide you with a scale of average investment amounts. Using the lowest end of that scale as a goal is great, but the realities of opening your location may be very different. Every franchisee should be prepared to invest the higher amount to be safe. Having a financial cushion is important—no business closes because the have access to too much capital.
2. Utilizing Too Much Liquidity
Having liquid capital in reserve is important, you will need it to fund the first few months of your business. When your bank account approaches zero before you open your doors, you will encounter problems and going back for another loan may not be possible. Be realistic and protect your liquid capital.
3. Not Listening
You've selected a franchise concept you believe in. Your success depends on listening to their experience and following their structures. They have a tested system. It works. They know where the pitfalls of the business are and you are giving them a royalty to make sure you don't stumble into those pits. Once you start to cherry-pick processes, you will begin to spin your wheels and waste your money. You may think you know better, but the franchisor has probably been down that road already.
4. Looking Too Late
It's never too early to begin looking at funding. Make sure you shop around. Look at your local bank, online institutions, and franchise funding specialists to compare rates and experience before making a final decision.
Getting quotes from financial institutions will also help during your discovery process.
When you shop for a home, you get a pre-approval to make sure you can afford your dream home. Looking for franchises is no different. Each franchisor will have different funding requirements and you want to be able to invest in the franchise you fall in love with!
5. Tripping Over Dollars to Save Pennies
Getting the best deal on your loan doesn't mean you go the best loan. A local lender will be happy to provide the loan you want, but they may not have the experience to structure the loan appropriately. Pay for experience and make sure whomever you choose to provide your financial support has experience in franchises. You may save money upfront, but lose money on the back end when something goes wrong. We cannot give better funding advice than to select a professional team to help you through this process.
Franchise Funding Options Galore
There are many funding options available to you when you are looking to build your franchise empire (or single unit). Knowing the different types of loans and equity is important to your success. Whether you decided on an SBA Express loan or a home equity loan, using franchise lending professionals can make a huge difference. Getting funding for a franchise is not difficult. The consultants at HIRE YOURSELF can help introduce you to trusted financial advisors to help build your success and put you on the road to freedom from the corporate world.
Ready to consider taking the first step to HIRE YOURSELF? We are here to help you find the best franchise match for you.
This article is written based on an interview with Shirley Kefgen, a Senior Funding Consultant at FranFund.
