Investing in Franchises: 5 Critical Funding Tips You Need to Know Now — Not Later

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Thursday, December 28th, 2017

According to data compiled by Statistica.com, the number of franchise establishments in the U.S. climbed to 745,078 in 2017 — the fifth straight year of increases, and a 6.75% rise from 2013.

If you’re considering joining the ranks of successful franchisees, then there’s a good chance that you’ll need additional funding. To help you head in the right direction and ensure that your entrepreneurial journey is personally rewarding and professionally profitable, here are 5 critical franchise financing tips you need to know now — not later.

Investing in Franchises Tip #1: Explore All of Your Options

Even if the franchise you’re thinking of purchasing offers financing, it’s in your best interest to explore all of your options — including solutions in the alternative lending marketplace. For example, asset-based financing may be ideal for buying new or used equipment, fixtures, signage, and so on. Since you’ll be purchasing the equipment instead of leasing it, you’ll exploit attractive tax deductions such as loan carrying costs and asset depreciation.

What’s more, not all franchises offer the same type of financing (and some don’t offer it at all). Each has its own rules and structure; some of which are not particularly “franchisee-friendly” — such as massive balloon payments that suddenly become due and must be paid in full. By researching and obtaining your own financing, you’ll be in control and can choose the structure and payment schedule that make sense for you.  

Investing in Franchises Tip #2: You’ll Need More than the Franchise Fee

While the franchise fee will typically be the biggest cost to cover, keep in mind that you’ll have other expenses such as renovations/improvements, insurance, staffing, and so on. Factor all of these anticipated costs into your strategic borrowing plan, so that you don’t end up having to race back into the lending marketplace to raise more capital — which could be risky, costly and stressful.

At the same time, it’s wise — and some franchise experts would say mandatory — to never invest more than 75 percent of your cash reserves, in order to have capital available for contingencies (both expenses and investments).

Investing in Franchises Tip #3: Don’t Count on an SBA Loan

Banks typically don’t lean forward to provide funding to would-be franchisees with impaired credit, or who don’t have a long and proven track record of business success. Even if you knew this already, then unfortunately you shouldn’t necessarily count on the SBA providing you with a loan guarantee. Yes, banks are much more willing to lend funds when Uncle Sam is backing upwards of 90 percent of the loan. But competition for SBA-backed business loans is fierce, and the annual funding pool typically dries up by about September.

As such, while you can certainly try to see if an SBA loan is possible, it’s unwise to view this as your only option — because there’s a very high chance that you won’t get the funding you need (or won’t get it in time) to seal the franchise deal.

Investing in Franchises Tip #4: Your Nest Egg May Need to Stay that Way

Some entrepreneurs tap their retirement savings (e.g. 401(k), IRA, etc.) to purchase a franchise and cover associated costs. Obviously, the amount withdrawn is taxable at prevailing rates, and the funds can no longer generate tax-free interest. But that’s not where the warnings end.

The IRS has signaled that it views the practice of using retirement funds to purchase a franchise (or any other business for that matter) as “questionable,” and a number of taxpayers who have pursued this option have found themselves slapped with a massive tax reassessment — leading to shocking 5 and 6-figure arrears bill.  

What’s more, the process of using retirement funds for an entrepreneurial investment is complex, and most people need to hire a consultant to steer them through the bureaucratic maze. While consultant costs vary, the price tag starts at around $5,000 and can easily exceed $10,000.   

Investing in Franchises Tip #5: Work with a Lender Who Understands Small Business and Franchising

Some lenders have experience with franchisees, but that doesn’t necessarily mean that they understand small business — which has its own aspects, nuances, risks and opportunities. It’s wise to choose a lender that understands both sides. That way, you’ll get the funding you need to launch your franchise, and get the ongoing support and guidance you need to keep it strong and successful for decades to come.

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