Creativity and Patience Needed In Seeking Franchise Funding
By Leslie Lautzenhiser
It’s a Wednesday in Fort Collins, CO. Craig Raddice, the owner of the Pooch Mobile, a mobile dog washing service is out enjoying the sunshine, meeting new customers and enjoying the life of a reinvented man. Having exited from a long-term telecommunications career over 5 years ago, Raddice took a gamble with an investment from his personal savings account and purchased a Pooch Mobile franchise with a lump sum cash payment.
While Raddice had the necessary cash on hand to purchase his franchise, many would-be franchisees are grappling with how to pull together the necessary funds to launch their franchise dreams.
“Every day I speak with individuals who are interested and motivated in buying a franchise, but they are not educated on the cash it requires for such an investment, nor do they have a strong enough credit or net worth position for them to qualify with the franchise company to be a franchisee,” said Stephen Hogan, a franchise consultant with FranChoice.
“It can be a little misleading in advertising from some franchise companies about what it takes to purchase a franchise,” Hogan added. “I have many people come to me stating they’d like to buy a nationally known sandwich franchise because they saw on their website that franchises start at $15,000.”
The reality of the situation is that the total investment level required for most franchises that could yield a five figure plus income to its owner averages in the $125,000 to $150,000 range. For nationally known food and retail types of businesses that figure is easily doubled or tripled.
The initial franchise fee, generally listed in some franchise advertisements is just one small component of the total investment in a franchise. In addition to the franchise fee, there may be equipment, inventory, marketing items, leases, vehicles and other items that would be required to launch the business. Franchise companies also want to see the prospective franchisee have at least a six month cushion for operating and living expenses.
According to James Wahl, ESQ of the Minneapolis law firm Monroe, Moxness, Berg, not having enough working capital to get to positive cash flow is one of the factors that would most likely to contribute to the demise of a new franchise business.
“Having enough working capital to get through the first six moths to a year is absolutely critical, “Wahl said. “If the franchise company allows a franchisee to launch their business without this reserve, they are looking at a strong likelihood of failure in their new franchisee.”
With the ever tightening of the credit markets, it has become more and more difficult to secure financing to launch a new business. This has forced most franchise companies and prospective franchisees to become more creative in their financing approach.
“I’ve seen a trend towards franchisors becoming their own internal financing company for qualified franchisees,” Wahl said. “In addition to this some franchise companies have launched a “lease to own” type of arrangement whereby a franchise owner would pay the investment back over time before officially becoming the owner of their business.”
The real estate market downfall has trickled down into banks offering business loans as well. Though the SBA is on hand to assist banks with loan programs, it is not a lending institution, nor does it guarantee to a bank 100% of the funds it lends to potential franchisees.
Banks then are left to their own devices as to whether they implement some of the SBA loan programs and what types of loans and criteria required for lending they have for start-up business financing.
“I’m finding that it’s much easier to get a follow on loan for a second location than it is for a primary business,” Wahl said. “Unless the potential business owner has very strong personal collateral and credit, it is difficult to secure initial business financing.”
Sherri Sieber, Chief Operating Officer with FranFund, a company that assists would-be franchisees in various financing programs says, “five years ago you could have gotten a dog an SBA loan, but it has become increasingly difficult to secure traditional bank financing now.”
Her company works with potential franchisees to put together a loan application package that helps banks better process loan requests by ensuring all the necessary loan documents are packaged and the candidate is shown in the best possible credit light to the potential lending institution.
“Banks have stacks of loan applications on their desk and only approve so many loans at any given time,” Sieber said. “Depending on their portfolios, they may be approving more auto or home loans over business requests. There are many factors involved in even getting a bank to review a loan application.”
Sieber also said that some banks would rather focus on loans requesting a higher amount than those requesting $150,000 or less. “The more money requested, the more likelihood, the loan applicant has better collateral and is a lower risk.”
Where can potential franchisees turn for funding if a traditional bank loan is not in the cards?
Sieber’s company works with many funding programs including, securing lines of credit and 401(K) rollover loans for business purchasing. Paul Aludo of Aurora, Colorado turned to FranFund in securing financing for the franchise he has been investigating. With a solid cash balance in the bank and impeccable credit, though not employed at the time, he was able to secure nearly $90,000 in lines of credit through various credit card companies which allow him to have the total investment level needed to move forward in his purchase.
A somewhat less known path towards financing lies within the 401(K) plans of would be franchisees. The IRS allows a business owner to borrow all or part of their 401(k) to purchase a primary business. There are certain regulations and requirements for this type of financing, but it has become a very attractive and increasingly popular method to fund a start-up business.
“There is the issue of risk so it’s very important everyone be well informed, “Wahl cautioned. “Business is a risk and this is risking a portion or all of your retirement savings.”
Sieber says; however, that through proactively managing the 401(k) account after the business gets up and going, business owners can begin depositing money back into their 401(k) plans and rebuild the principle they pulled out to fund their initial investment.
Ben Heerema purchased his franchise in southern California through his 401(k) plan. “It was the best alternative to getting the money I needed to make the investment,” Heerema said. “The process was seamless and the company I used helped me incorporate, set up me with an accountant and liquidated the money I needed to be able to purchase my business.”
Potential franchisees can also find traditional and local approaches to funding their business. Sieber stated that if a potential franchisee has a good relationship with their local bank and has multiple accounts at the bank, it is quite possible they may be able to better achieve approval on a traditional loan than seeking a loan through a national bank where they do not have a relationship.
Local credit unions and community banks tend to be more amenable to business loans, especially if there is a long banking history with the applicant. Other alternatives outside of bank loans include second mortgage lines of credit, traditional credit card lines of credit and loans from family and friends.
Sieber says that both franchise companies and lending institutions are increasing their requirements for consideration of loan approval as well as approving candidates as franchisees. She stated that a 720 credit score is generally a low average of what banks and other credit institutions are looking at as a minimum score for consideration for unsecured SBA and traditional loan lending programs.
What does this all mean for a would-be franchisee? There is money out there to be lent to start-up a business, but the individual seeking the loan has to be able to demonstrate they have strong credit, collateral and access to other means of start-up capital (employment earnings, real estate and savings in the bank).
Franchise companies are looking for candidates who have a solid net worth, credit and cash position before approving them to purchase a franchise. A high turn-over of franchisees going out of business due to under capitalization hurts the entire network, so anyone looking to buy a franchise needs to expect they will have their finances scrutinized while going through the investigation process.
Sieber recommends anyone looking to buy a franchise invest the time to do a consultation with a lending company, or others in the industry that can give a candidate an honest and realistic approach as to the total investment the candidate can likely be approved for through various loan and funding programs. This will let the potential franchisee know what types of franchises would be a fit for them financially and will give them the confidence they can purchase the franchise and still have money to operate it during the first year or more.
Experts also advise an annual credit review so no surprises are found during a loan application process.
The economy is improving and new businesses are opening their doors every day, but money isn’t flowing out of the door by banks to fund new businesses. The American dream of business ownership is still alive, but it requires creativity, patience and access to many types of financing options.
About the Author:
Leslie Lautzenhiser, is a franchise consultant with FranChoice and is the author of “A Roadmap to Success: What it Takes to Build a Successful Franchise”. You can learn more about her by visiting her website at www.start-my-franchise.com
