You have carefully read the information, done all of your due diligence, weighed up your chances for success, and have decided that a franchise is the route you want to take to start a business.
However, before you sign anything, you first need to answer this question: Where are you going to obtain the money for financing your franchise, working capital, inventory, and royalty fees?
Before you approach a lender the first thing that you should do is determine your net worth. In order to do that a personal balance sheet is used to list your assets (the things you own) as well as your liabilities (how much you owe). On the assets side, add up all of your holdings – checking accounts, cash on hand, saving accounts, securities, bonds, vehicles (whether or not they are paid off), cash values on insurance, and another other assets that you own – and then total them together.
Liabilities are the other part of a balance sheet. Follow the exact same steps that you used for determining your assets. List all of your current bills, your home mortgage, credit cards, finance company loans, auto loans, personal loans, and so forth. Then take the total of your liabilities and subtract them from your assets. After you have your balance sheet complete, check your credit rating. All potential lenders look at three common factors when checking a credit rating: track record, income, and stability.
Most lenders want to know how long you have lived in the same place or been at a specific job, and whether or not you have a track record of completing things that you start. You need to be prepared with a good explanation if your history doesn’t show a record of stability. The amount that you earn is very important but being able to live within your means is also key. There are some individuals who earn $100,000 per year that still are unable to pay their debts, but other people are able to stay within their budget on $20,000 per year.
There is a very good reason why a majority of lending institutions review your income and how you live within your income. If you are unable to manage personal finances, there is a good chance you won’t be able to successfully manage your business finances either.
Your track record is the third thing that lenders look at – which is how successful you have been able to pay your past obligations off. If you have a track record of repossessions, delinquent payments, and so forth, you will want to get those cleared up before you try to get a loan.
A majority of lenders contact credit bureaus to check your credit file. We recommend that you do the same exact thing before attempting to borrow any money. Credit bureaus under the law are required to provide you with all of the information that they have on file that is associated with your credit history. After you have this information, make sure to get any errors corrected or at the very least be sure to get your version of the story on your credit report. For example, a 90-day delinquency will look bad, However, if the cause of your 90-day delinquency was due to illness or being laid off, then that should be considered.
Once you have determined what your credit rating and net worth is, the last step that you take before you approach lenders is to put your business plan together.
Having a carefully-thought-out business plan is something that can make a significant difference between your loan application being rejected or accepted. A comprehensive plan always should include a close technical study of whatever business you are planning to go into; accurate cost analyses, projections, and pro forms, working capital estimates; a demonstration of your “people skills”; and an appropriate marketing plan. Your business plan should also include several credit references and certified statements on your net worth.
If you aren’t familiar with creating a business plan, get professional help or review business plan preparation software like BizPlan Builder Interactive or Business Plan Pro.
The first place that franchisees traditionally have turned to for financing are their franchisors. Nearly all U.S franchisors only provide debt financing. Some carry either a fraction or an entire loan via their own finance company. There are fractions ranging from 15 percent to 20 and 25 percent and up to 75 percent of the overall debt burden.
The loans that the franchisor makes can be structured in several different ways. There are some that offer loans that are based just on simple interest with no principal, and then in five or 10 years, there is a balloon payment due. There are others offering loans where there are no payments due during the first year.
Rather than financing the whole start-up cost, some franchisors might offer financing for part of the total cost. They might have financing plans for operational costs, the franchise fee, the equipment or any combination of these.
Along with start-up costs being partially financed by the franchisor, they also normally work with leasing companies to arrange for the franchisee to lease the equipment that they need for running their franchises. That can end up being a significant part of the overall financing, given that equipment frequently runs from 25 to 75 percent of the total start-up costs for a franchise.
If you are considering a franchise that doesn’t provide equipment leasing, check with non-bank, non-franchise companies specialising in providing franchises with equipment leasing. These kinds of financing companies frequently offer asset-based lending for financing the franchisee’s fixtures, signs, equipment, and furniture, and also allow the franchisee to buy the equipment once the lease has ended. Remember that under current law you might lose some tax advantages when leasing equipment.
Keep in mind that there are two main reasons why a business is franchised: to raise capital and for expanding the business. Therefore, if your credit record is reasonably good and you meet all of the financial requirements, a majority of franchisors will do everything they can to get you on board to join their team. The assistance that is provided by franchisors will usually help you get financing that includes help with business plan preparation and introducing you to various lending sources. Many times, franchisors will act as guarantors of the loans that you get.
Other Financing Sources
Once you have determined what financing is being offered by your franchisor, your next step is to make a list of all other sources of capital that are available. The following contacts are used by most sharp business people: finance companies, SBA (Small Business Administration) loans, bank loans, veterans’ loans, home mortgages, and loans from relatives and friends.
Banks are frequently not willing to work with certain individuals based on their financial profile. However, when there is an SBA loan guarantee they can become more amenable. The SBA guarantees those loans up to 90 percent. All a small business needs to do is submit their loan application to their lender for it to receive an initial review, and then if the loan application is found to be acceptable by the lender, its credit analysis and the application will be forwarded to the closest SBA office. Once SBA approves it, the loan is closed by the lender and the funds are disbursed. The borrower will then pay back the lender by making loan payments.
Some franchisors have reported that financial brokers have approached them – whereas historically it was only the big deals that they were most interested in. They do this to put large pools of money together using private funds and the SBA. Those funds are then available to franchisees via the franchisors similar to a trust fund. The fund would be contributed to from groups of small banks that have funds to invest from all across the country.
Other potential options include taking out a second mortgage on your house or getting a home-equity line of credit. However, you need to be careful when using this kind of financing. Keep in mind that a second mortgage and home-equity line of credit are both secured by your house. If you are unable to repay the amount you are financing from this source, the you could be risk for losing your house.
Tips For Your Consideration
There are numerous financing sources that are available to help you with launching your dream franchise. However, it can be disastrous running a franchise without having any reserves and being blind to unexpected business problems that can arise. A good rule to keep in mind: You should never invest over 75 percent of your total cash reserves. So don’t invest any more than $7,500 if you have a total of $10,000. Invest $18,750 if you have a total of $25,000.
Most important of all, keep in mind that a franchise’s price isn’t always a reflection of the real cost of the actual business. There can also be additional costs that may also include payments on signs, fixtures, equipment, building and land, and may cover administrative costs, opening promotional costs, training, leasehold improvements, inventory, and sales commissions at times.
Make sure you have a good understanding of your cash investment requirements. You are going to need to have a cushion of working capital in order to guide your business properly through all of the ups and down. However, if you do thorough research, and keep in mind that the most important sale that you will ever make is financing a business, then you will be well ahead of your competitors.
15 Quick Franchise Financing Tips
1. Speak to your franchisor before you search for outside financing; get pre-qualified or approved.
2. Family and friends are the most common start-up capital source. Make use of this.
3. Look for lenders who understand franchising in addition to small businesses.
4. Be completely upfront and honest with lenders. Don’t hide anything. Be prepared to explain anything and everything.
5. It is important to be neat. Fill out your loan and credit applications out clear. It is best to type them.
6. Don’t weigh your application down by having a lot of documents attached.
7. Don’t use up all of your liquidity by paying outstanding debts off before you file your loan application. Lenders like you to have some available capital.
8. If you are lacking in liquidity, find a partner who has money.
9. To improve your balance sheet and conserve start-up capital, consider equipment leasing.
10. Minimize your expenses and debts. Many business owners end up taking too much debt on and forget that they need cash flow in order to pay their debt.
11. Consider purchasing used vehicles, furniture, equipment, etc.
12. Before you waste time, gas, energy, and phone calls, use the internet first. There is so much useful information that is available. There are even websites that let you file your loan applications online.
13. Don’t forget about venture capitalists and angel investors.
14. Avoid taking out money from your children’s college funds or your retirement money. There is risk involved in all startups – including franchises.
15. Never give up.