Congratulations for investigating the world of franchising!
A franchise is a very predictable and safe way to enjoy the benefits of being an entrepreneur. Financing a franchise purchase is often a topic that people do not address early enough in the process. Although there are many great business and franchise opportunities available, how you finance your franchise venture often determines the level of success you will enjoy. Is your personal credit good? Do you have management or strong work experience? Can you invest 25% as a down payment toward the total cost of the business? Then, you should be able to receive funding toward a franchise investment. Traditionally, there have been four ways that people finance a business:
1. Loans Guaranteed by the SBA
The SBA doesn’t lend money! This is a common misconception that many people have. They simply work with banks to get your loan. Your chances of obtaining a loan often improves when working with the SBA; however, it will likely be more expensive (and time consuming) to obtain this method of financing for your franchise.
2. A Bank Loan
Tell a bank that you want a loan to start a new business…you won't get any money unless you can prove you don’t need the loan because you can completely collateralize the business with assets such as cash, stocks and home equity.
3. Home Equity
Many people have enjoyed the increase in home equity over the past 15-20 years. However, with the current situation in the housing market, this may not be the best option for you. If you have considerable equity, this may be an alternative. If not, you will need to look elsewhere.
4. Using 401k or IRA funds
The thought of pulling out some or all of that money was not much of a consideration based on the penalties you heard you would pay for early withdrawals. Two things have changed and both of them have opened up new financing opportunities for people wishing to start their own franchise or business.
The first one is that the stock market is not what it used to be. Old long term growth rates just arn't likely to return. I keep hearing things like “maybe I’m better off betting on me to grow my investment dollars instead of the people who manage my funds now”. But if you take your 401k funds out early, won’t those penalties really hurt?
There has always been a little known but safe and legal way to use retirement funds to invest in your new business without paying any penalties or taxes. This can be accomplished by rolling over some of your retirement funds into a qualified retirement plan in your own company. This allows a prospective new business owner to release the money in his or her retirement plan and use it for a fresh start in business. You can do this without penalty and without taxes, using a section of the Employee Retirement Income Security Act. Small business planning and retirement funding provides a new business owner with a proven method to use his or her IRA or 401(k) rollover assets to invest in a new business. We have long standing relationships with companies that not only specialize in these rollovers but can assess all your potential funding sources.
NOTE : If you are a military veteran, be sure to ask about a program available to veterans called VetFran. Franchise companies participating in this program give discounts to veterans as a thank you for serving their country.
Q I've found the franchise I want, but I don't have enough cash to completely fund the startup of the business, so I'm going to need to get a loan. I'm just starting to talk to banks, and they seem to want a number of things I don't have, such as a complete business plan with projections for the business. They also expect me to personally guarantee the loan even though the business is a corporation. Is my best option to use the SBA in order to avoid these hassles or what should I do?
A This is the number-one topic for questions we receive. The best source of information about your financing options is the franchisor. They should be able to tell you, from experience, how likely it is for you to obtain financing from any particular source. It may also be helpful to understand the principles that underlie your ability to get financing, regardless of the lending source. There are four "Cs" involved in any decision to loan money to someone: Cash, Credit, Collateral and Character. The fact is that it doesn't matter whether you go to a bank, use the SBA guarantee service or go to a friend or relative for the loan.
Cash - One of the most common misconceptions people have is that they can borrow all the money they need to open a business. Unless your personal net worth is far larger than what you need to borrow, this is almost certainly not true. For SBA loans, you'll most likely have to come up with funds—either from your own assets or other sources—probably equal to at least 25 to 30 percent of the total investment needed to start the business, before the SBA will consider lending to you. Lenders like to make sure you personally have "skin in the game."
Credit - Another thing lenders insist on is a strong credit history. This means they want to see a track record of you borrowing money and making your payments on time. Though your home mortgage might be the best example of a large loan you have serviced well, you'll find you get almost no credit for that type of loan. Everyone realizes most people will take care of their mortgage before their other bills, so what they really want to see is a pattern involving timely payments on other types of loans. While a good credit history doesn't mean you'll get a loan, a bad one almost guarantees that you won't. In todays economy, it is best to have a score over 700.
Collateral - Most lenders require you to completely secure any loan you want with personal assets sufficient to provide for 100 percent recovery if you default on the loan. In many cases, franchisors can recommend lenders with whom they have had a good experience. This may include someone other than a direct lender -- since these firms are often able to select the best source of financing from a pool of aggressive lenders. These firms are very familiar with Small Business Administration guaranteed loans. It doesn't matter one bit whether your business is a corporation or any other type of entity, or whether you go through the SBA process—they are going to look to you for collateral.
Character - The final condition you must meet relates to your character or reputation. Frankly, this is like your credit history—having great character won't ensure you'll receive a loan, but having a bad reputation will almost guarantee that you won't. Having strong enough character and a great reputation used to be enough to offset a lack in some of the other Cs, but those days went out the window with the S&L crisis 15 years ago, at least as far as any regulated lender is concerned.