How to Fund Your Franchise Dream

It’s the simple truth: a franchise is a big purchase. The cost is often similar to (or even more than) that of a family home, and for good reason. When you buy a franchise, you buy a?business system?that has already been tested and refined for success. You don’t have to worry about burning through your cash while you figure out product-market fit, operational efficiencies, and the many other details that often prove fatal to traditional business ventures. But this does mean that franchising usually involves more?up-front cost?than starting a traditional business. As a result, you need some idea of how to fund your franchise dream.

Why a Funding Strategy Is Important

If you were a franchisor, which franchisee would you choose: the one who has their funding lined up and ready to go, or the one who’s still not sure how they’re going to pay their startup costs? You’d choose the first person, of course. It’s a basic rule of business: liquidity wins. And that’s why it’s so important to have a funding strategy for your franchise.

Before you even start narrowing down your list of possible franchisors, you should know the answers to the following questions:

• What’s my?personal balance sheet? How much cash do I have on hand to fund franchise startup costs?
• Am I willing and able to borrow money to help fund my startup costs?
• How will I pay my bills?until I can draw a salary from my business?

Franchisors will want to see your financials as part of the?vetting process, to satisfy themselves that you have enough liquidity to pay your startup costs and maintain the business until it’s profitable. If you intend to obtain financing for startup costs, they’ll want to know that you’ve already qualified for it or can easily do so. And they’ll want to feel confident that you have a solid strategy for paying your bills in the early days, since personal financial strain can lead a franchisee to throw in the towel.

If you?work with me, you’ll complete?a formal self-assessment?to help you think about how to fund your franchise. I’ll also connect you with a funding specialist early in the game, to finalize your financial details. This helps ensure that you’ll stand out well against other applicants during the franchisor’s vetting process. Keep reading to learn more about the types of options your funding specialist might suggest.

Funding Options for Your Franchise

Cash

If you have a very healthy balance sheet, you may be able to pay cash for your franchise startup costs. You might also use cash for part of your startup costs and obtain financing for the rest. Cash funding usually comes from a source such as an inheritance, personal stock portfolio, or the sale of a major asset (e.g., a vacation home).

While cash has the advantage of allowing you to start your business with less debt, you shouldn’t use up your entire nest egg to buy a franchise. Maintaining an emergency cushion is important, both for you and for the business. And most candidates use financing as part of their funding strategy, so franchisors don’t necessarily downgrade a candidate because of it.

Retirement funding

You may want to pay all or part of your franchise startup costs using a loan from your retirement account. A?401(k) loan?is the most common arrangement, but other types of retirement accounts allow for loans, too. Keep in mind that these types of loans are often subject to special requirements. For instance, loan amounts are usually limited to $50,000. And if you take a loan from a 401(k), you’ll have to repay it more quickly if you leave your job, so this option is best if you intend to?operate your franchise as a side hustle.

Another popular retirement-based option is the?Rollover For Business Startup?(ROBS) program, which allows you to convert your retirement funds into an investment in your new business.?This strategy is not a loan and may enable you to eliminate or reduce the need for additional funding, allowing you to start your business debt-free without loan payments that increase your overhead. Since this reduces your total retirement nest egg (unlike a loan, which you must eventually repay), it may work best for situations where your franchise is?part of your retirement plan.

A funding specialist or your financial advisor can help you determine whether either of these options is right for you.

SBA loans

Nearly half the U.S. workforce?is employed by small businesses. The Small Business Administration (SBA) is a federal agency that exists to support this vital sector of our economy, including franchises.

Among other resources, the SBA offers loan programs for small-business owners. Four types of SBA loans are especially relevant to potential franchisees:

• Standard 7(a) loans.?These loans can be for up to $5 million and require eligibility determination by the SBA. Turnaround time on a decision is usually 5-10 business days.
• Small 7(a)/Express loans.?These loans have similar terms to standard 7(a) loans. While they technically have a maximum loan amount of $350,000, most banks limit these loans to $150,000.
• 504 loans.?These loans can be for up to $5 million. They must be used specifically to purchase or build “major fixed assets” such as facilities or equipment, so they are most applicable to?brick-and-mortar franchises.

A funding specialist can help you determine which, if any, of these loans might be a good fit for your franchise funding strategy.

HELOC

A?home equity line of credit, popularly referred to as a HELOC, borrows against the equity in your primary residence. HELOCs often have comparatively low interest rates and flexible repayment terms, and the interest is sometimes tax-deductible. In addition, because they are a line of credit, you borrow money only as you need it. This can enable you to keep your debt low.

On the flip side, HELOCs use your home as collateral, and the interest rate varies over time. Because they function somewhat like credit cards, with small minimum payments and a loan amount that piles up over time, they also work best for borrowers with strong financial discipline.

Other financing

Retirement loans, SBA loans, and HELOCs are the most popular methods for franchise financing, but they are not the only choices. If these options don’t sound appealing to you, but you still need to figure out how to fund your franchise, consider the following:

• Franchisor financing.?Some franchisors offer financing, either directly or through partnerships. They may waive fees for loans from specific lenders or offer better interest rates or repayment terms than you could obtain through a private loan from a bank. However, always compare terms carefully to make sure you’re getting the best deal.
• Private loans.?In certain circumstances, you may need or prefer to go directly to a bank for a private loan. Private loans are likely to have less favorable terms than a specialized loan, such as one from the SBA, but they may be more flexible and allow for on-the-spot approval. Especially if you just want to borrow a small amount of money for a short time, you might prefer this path.
• Unsecured Loans.?Unsecured loans don’t require collateral and are made on the basis of your income, credit-worthiness, and spending patterns. They often have a relatively quick turnaround time of 3-4 weeks. However, because of the lack of collateral, they generally involve higher interest rates and fees.
• Business grants.?Various federal and private entities offer grants to help people start small businesses. Grants tend to be on the small side, so they usually work best as a supplement to other forms of funding. They are most often available for niche businesses and for underrepresented groups (e.g., veterans or women business owners).

Regardless of the option you choose, one rule of thumb applies across the board: when you’re thinking about how to fund your franchise dream, make sure you investigate your options early. The sooner you can nail down your financial situation, the stronger your position will be. And if you need some help understanding your options??Book some time on my calendar, and we can start the conversation about what’s best for you and your family.