Franchise Financing

 Finding The Best Sources For Financing Your Business
 Financial Requirements Set By Franchisors
 Choosing A Source of Capital
 Got Questions?

Finding The Best Sources For Financing Your Business

It is better to lose the friend, rather than the house.
A somewhat tongue-in-cheek response when someone at a seminar on raising money for business ventures asked about the risks of asking  friends and family to invest in your business.

In most cases, piecing together the financial package is a challenging, but not an impossible task. The majority of franchisees do not receive all their funding from one source. Rather, they use a combination of sources to finance their businesses. First, they see how much they can contribute from their personal savings. Then, roughly in the order of popularity, they turn to family or other investors, franchise system financing, bank loans, government programs, a note to the previous owner in the case of a resale, lines of credit, home equity loans, limited partnerships and venture capital. A discussion of these sources, as well as a few more ideas later in this webpage, should start you off on the right track to financing your chosen business. 

Before you begin to try raising the necessary capital, you need to take a realistic look at the financial burdens. No matter how great a business person you are, chances are slim that you can put together a financial package for a major fast-food franchise that requires an investment of $750,000 or more, if you have little or no collateral. Actually, it is doubtful that you will even get this far because the lack of collateral will show up on the franchisor's qualifying questionnaire, and the evaluation process will have already come to a halt.

Financial Requirements Set By Franchisors

Many of the franchise systems have minimum financial requirements if which may, or may not, be communicated in a public way. Some systems will talk to prospective franchisees about financial stipulations only after they have reviewed the prospect's qualifying questionnaire.

In any case, be sure that the franchise of your choice is within the realm of your financial capabilities. Before you get into heated discussions with the franchisor, find out exactly what the franchisor considers to be the mini- mum financial requirements to license the franchise.

Some examples of franchisor requirements for franchisees follow (not all of which are financial).

• Del Taco, a fast-food restaurant system, requires franchisees to have a minimum net worth of $2,000,000 and minimum liquid assets of at least $250,000. A prospective franchisee must also develop a minimum of five locations to be granted a franchise. Franchisees are also required to have substantial quick-service restaurant operations experience. 
•  Valvoline Instant Oil Change, an auto aftermarket service, generally requires that individual licensees show a net worth of $200,000, exclusive of equity in her or his primary residence, with $100,000 of that $200,000 in cash, marketable securities or other liquid assets. Corporate and partnership licensees are expected to show the capacity and liquidity necessary to make the investment required, using the net worth and cash equivalent figures noted above.
• Checkers Drive-In Restaurants require that prospective franchisees have a minimum net worth of $500,000 and minimum liquid assets of $200,000 excluding personal residence. 

Choosing A Source of Capital 

If you can finance the business entirely from your own personal funds and savings, congratulations, you can skip this section. If that is not the case, read on and engineer your plan of action.
Maybe you have a majority of the money needed, maybe a portion or maybe none at all. The shortfall-the money that you don't have to pay the franchisee fees, to cover the start-up costs and to fund daily operations-must be borrowed or raised.
 
Using Debt

If you borrow the money, you are using debt financing. You will probably borrow from one or a combination of the following: commercial banks, government-sponsored bank loans, franchise system loans, home equity loans and credit card loans. Then, too, if your franchise is a resale, you may be able to arrange a payment plan with the previous owner, whereby you pay a set amount each month to buy the business on installment. 

Using Equity

Although debt financing is far more prevalent for franchise investments, equity financing is another way to raise money. The primary difference between the two is that with debt financing, you will have an obligation to pay back the borrowed sum, but you will retain control of the business; in equity financing, however, you are giving up a part of the business to an investor or investors in exchange for their financing. The investors will claim some control of the business operations; they will own some of the assets; and they will share some earnings. You will not have a set debt obligation to repay as you would with a monthly loan payment to a bank, however. The investor will be taking a risk as to when and how much of the investment she or he will recoup, as well as whether there will be a return on the investment.

Family and Friends

One of the most common ways of finding equity financing is by having family and friends invest. They are often the first sources of franchise financing that come to mind for many franchisees; After all, family and friends know your capabilities, and they want to help you succeed. As investors, they will, no doubt, want to have some input into how the business is run and be regularly appraised as to the progress of the venture. These demands are perfectly consistent with the role of equity investors.
 
The threat of problems and potential discord, however, looms larger when the family or friend investors are directly involved in the operation of the business. To be sure, some of these set-ups work very well, with everyone pulling for a common goal. However, it is more probable that you, as an owner-manager, will have to resolve conflicts between what is good for the franchise and what family or friends think is good for them. In general, you can anticipate more stress in a family-owned business, even if you are the largest stockholder. You will have to be tactful and patient with the family investors. When several family members invest in a business, the conflict often revolves around defining priorities--the business or the family.

Partnerships

Another financial route is to take a partner. In a partnership, you will share the equity of the business with another person. Such a relationship can develop by simply discussing your franchise opportunity with a friend or acquaintance and deciding to go into business together. The partnership may be established by oral or written agreement. However, I strongly encourage you to engage an attorney to formulate a written agreement that clearly details the partners' rights and obligations.
The most important thing to remember in any partnership arrangement is that the relationship must be based on trust and confidence. Your capital and your personal assets can be put on the line by a partner's actions. Whether your business thrives or fails will depend largely on your choice of partners.

Another way to raise capital using business equity is to team up with a venture capital firm. Although some franchisees have received venture capital support, most venture capital firms would not even consider funding a single location franchise. They are generally chasing the big deal where the capital requirements are in the million dollar range, and where the business can generate a very high return on investment. If you are considering a multi-unit franchise deal, a large territory agreement or a high cost investment, such as a hotel or motel franchise, contacting venture capital firms should be at the top of your list.

Limited Partnership

Setting up a limited partnership is another way to sell equity in the business. The application of this method, though, has very limited use for franchisees. Limited partnerships are usually relegated to specific industries, most often the restaurant business and real estate developments. This type of partnership gives investors special tax advantages and the advantage of limited liability. If the business fails, limited partners can lose only their original investment, any additional capital contributions and their portion of the assets of the firm. General partners, however, have unlimited liability as in any ordinary partnership.

The general partner-the franchisee-is the person putting together the deal, usually someone who has managerial expertise and! or experience in the industry. The limited partners are simply investors who have little or nothing to say about the day-to-day operation of the business, but who ultimately expect to have their investment plus a nice return paid to them for the use of their capital.
You might include a leasing arrangement in your financial planning. This doesn't quite fall under traditional debt or equity financing. Often leasing is part of the package called "franchisor-sponsored financing," and it entails paying a monthly fee to rent equipment, furnishings and fixtures from the franchisor. Usually, there is a buy-out amount at the end of the leasing period, where you have the option of buying the leased equipment or furnishings at a pre-arranged price.

Leasing can be a very attractive option. Although you will pay a greater net amount for the leased equipment, it eliminates the need of coming up with the full amount to purchase the equipment for start-up. Also, in many industries, the equipment will be obsolete in five or ten years, so when your leasing arrangement terminates, you can sign another lease for the newest models.

In addition to franchisor-sponsored leasing, commercial leasing companies write leases on everything from computers to copiers, machinery, fixtures and vehicles. Most leases are for the long-term, maybe ten years, and require the lessee to pay all the expenses related to maintenance, insurance and taxes during the lease's term. Leasing often requires collateral from the lessee--such as the pledging of assets and personal guarantees.

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