Five Ways to Finance a Franchise

The companies on the Franchise 500 listing include a massive selection of price tags. You can open a Jazzercise exercise-class franchise for as little as $2,405, for example, or a Buffalo Wild Wings unit for between $1.99 million and $3.8 million. So once a prospective franchisee finds the right match for them, they must answer a big question: Just how are they going to cover it?

There are many options — from simple friends-andfamily loans to complex 401(k) investment techniques. Each comes with its own advantages and pitfalls, and, fiscal experts saythe ideal one for every person depends on their earning potential, current asset position, how much they’ve stored, their creditworthiness, and most important, their risk tolerance.

But that all sounds hypothetical, which explains why we wanted to observe how these financing plans perform in actual life. On the next pages, we profile five powerful multi-unit franchisees that each paid for their first franchise in another way. They reveal the up-front expenses, the size of their loans, and exactly what they believe of that choice today. We then run everything by E. Hachemi Aliouche, a professor and director at the University of New Hampshire’s Rosenberg International Franchise Center, who breaks down the advantages and disadvantages for any possible franchisee.

Finance Option 1 / Personal Savings

When Doug Porter decided to launch a career after retiring in 2015, the San Diego–established Navy veteran, now 62, set his sights on the hair-care business. “I considered two important factors. One was that this sector was not going to be bothered by the Amazons of the planet in my lifetime, and the other was that statistics showed this business is quite recession-resistant,” says Porter. “People do not stop getting their hair cut once the economy dips.”

To purchase an existing Sport Clips shop in San Diego, Porter chose to dip into his stock-and-bond portfolio for its $200,000 upfront expenses. “I knew I wanted to just use private savings,” says Porter, who consulted with a financial advisor to survey his fundingchoices. “I had a mortgageand that I didn’t want to take on new debt.” He had been using about 7% of his assets, and also the withdrawal represented investment gains from his portfolio. He also had health insurance from his then employer, so he was not concerned about unexpected, catastrophic medical costs that could hamper his retirement savings.

It worked. His first place was powerful, and he went on to purchase four more Sport Clips with the proceeds and another $50,000 out of his his IRA. (Because he’s older than 59 and a half, he still did not need to pay an early withdrawal fee.) “I believe I made the right choice,” he says, particularly since the IRA withdrawal was a little portion of their account’s value. “I was not extending myself”

PROS

“The best aspect of using private savings to start a company is you don’t have a monthly debt payment, so you don’t risk any loan defaults in case the company does poorly,” states Aliouche. “It is also a great option if you have terrible credit and can not be eligible for a loan”

CONS

“You are giving up the returns of stocks and bonds, and returns have been high the past couple of years,” says Aliouche. “Also, when you make use of money from private savings, you do not have that money to lean on for emergency expenditures.”

Finance Option 2 / Friends and Family

Danny Shenko learned about Tint World, a car-window-tinting and automotive-accessories firm, while researching possible new business opportunities in 2011, when he was 26. He fulfilled with the organization’s CEO, and things clicked. “The franchise was just starting out, but I connected with the CEO’s drive,” states Shenko, now 34.

Purchasing a Tint World store, however, cost $200,000 — and back thenhe did not have enough personal savings. He used a few wedding gifts, and he and his wife borrowed about $50,000 on credit cards. “Our good credit allowed us to procure zero percent credit card advances that allowed up to 18 weeks for repayment,” says Shenko. To cover the rest, he turned to those closest to him. His best friend offered to spend, but Shenko decided to not go through with ithe worried about harming the relationship if the business went south. Rather, his very best friend’s sister chipped in $30,000.

“There was some pressure to repay in a timely manner,” he says,”but something I know is that in business, you need to benefit from opportunities and constantly stay creative and flexible.” So he extended his finances and repaid the money a year and a half later launching. In turn, his friend’s sister did not charge him interest — even though they had signed an official agreement that contained an interest rate. Today all is well: Shenko simply opened his fourth Tint World, and has his very best buddy.

PROS
“If you have a friend who is willing to lend you money, it’s a great financing approach in the sense that you get fast access to cash, you do not have to hassle with banks, and also you do not have to have strong credit,” Aliouche states.

CONS
“If the business tanks, along with your friend who lent you the money has financial troubles, you might feel accountable,” Aliouche says. If you don’t feel comfortable with only a verbal agreement,”you can compose a simple recognition of debt,” for instance,”I, Jane, borrowed $100,000 from Joe. I consent to pay him back the full amount by December 31, 2020. Signed: Jane” — or have a lawyer draw up a formal arrangement.

Finance Option 3 / Traditional Bank Loan

Soon after Elliott Goldsmith heard of Firehouse Subs from a friend in 2001, he chose to pivot career paths. “I was hooked after the first bite,” says Goldsmith, then a 24-year-old working in a telecommunications company in Jacksonville, Fla..

Goldsmith set out to deliver the fast-casual restaurant to his hometown in Greenville, S.C.. After he contemplated applying for a Small Business Administration loan, he chose to open his store by using a five-year conventional bank instead. “The SBA loan only seemed a lot more complex,” he states.

Goldsmith used a local bank that had already issued loans to the Firehouse Subs company. “My lender knew the Firehouse story, so I did not have to go in and sell him about the concept,” he states. His store opened in 2002.

Now Goldsmith, 41, owns seven Firehouse Subs in the Greenville area. He’s used five-year regular loans, with fixed rates of interest, to start every location. He says that the organization’s low franchise fee of just $20,000 has enabled him to expand his business over the last 17 decades.

Goldsmith says he’d suggest the very same loans to other entrepreneurs — with a caveat. “Paying off a loan in five years might be pretty aggressive,” he says,”but if you have the cash flow to structure the payments within five decades, I would encourage a person to consider this type of loan.” In addition, he encouraged the use of local lenders because”in the end of the afternoon, there’s a good deal of value to have the ability to sit down in a room using a local banker and examine your financials and go over your plans for future developments,” he says.

PROS

“If you are trying to grow quickly, using a bank’s funding can make it possible for you to accomplish that,” states Aliouche. In addition,”the interest you pay on a business loan is tax-deductible.”

CONS

With traditional bank loans,”if you default on your payments, you could lose the business, and you might even go bankrupt depending on the type of bank loan,” says Aliouche. Moreover,”in case you have too much debt, it can make it even more difficult to acquire a second loan in the future” If you’ve got a poor credit score (anything under 650), you might have trouble getting approved at the first place, he adds.

Finance Choice 4 / Small Business Administration Loan

Nick Roerig and Gordon Shaffer became friends while working at a Two Men and a Truck franchise in Columbus, Ohio. They finally decided to buy their own franchise, and each saved up $50,000 for the purchase — but they wanted to buy an existing franchise in Brentwood, Tenn., which could cost more than $500,000. After consulting with a small-business-loan broker, Shaffer and Roerig employed for a $475,000 SBA loan through U.S. Bank, a bank loan that’s ensured by the national agency.

“We had no idea what we were getting ourselves into,” says Shaffer. The SBA’s application process is notoriously protracted, and theirs took four weeks. “It was quite stressful,” he states. “There were a lot of moving parts, and it looked like there was always another piece of paperwork we had to provide.” The loan eventually came through”in the eleventh hour, right before closure,” he says.

When the men were ready to obtain a second place, they employed for one more SBA loan, this time for $375,000. They used another bank, and this time it took only a month to become approved. But later, as the guys went on to purchase four franchises, they financed the purchase via the vendor. Shaffer says the procedure was”way simpler,” taking just per week.

PROS
If you can not get qualified for a conventional bank loan, then you may still be eligible for bank financing through an SBA loan. “Since the government subsidizes and guarantees SBA loans, they make it much easier for people with less cash or mediocre credit to be eligible,” Aliouche says. Interest levels are also generally lower than market rate.

CONS
SBA loans can be challenging. “The application process is quite bureaucratic and painfully time-consuming,” states Aliouche. The average SBA loan requires 60 to 90 days (depending on the creditor and also the size of the loan), however, Aliouche has seen that stretch to a number of months.

Finance Choice 5 / Tax-Free 401(k) Investment

Stan Shook spent 37 years in the gas-and-oil market. “I built large 401(k)s at the of my companies,” says Shook, 58. When he decided to purchase a Batteries Plus Bulbs franchise at Humble, Tex., which could cost $350,000 to start, he wondered if he could pull in part out of the $400,000 he’d in retirement savings. The answer was yes: Utilities Plus Bulbs provided Shook using a listing of vendors which specialize in helping entrepreneurs utilize 401(k) savings as startup funds — without needing to pay taxes to the cash.

Typically, if 401(k) owners withdraw money before age 59 and a half, they get slapped with a 10 percent early-withdrawal penalty, along with income tax on the sum withdrawn. But Shook was guided through a financing technique that solves the problem: He established his new company, and then that new entity opened a new 401(k) plan. Shook then rolled his existing 401(k) balance to the new plan — and, since he now controlled the investment options for this, he could use the funds in that plan to invest in the company. (This technique is risky, so don’t attempt it without consulting a financial planner and a lawyer.)

Shook ended up not carrying everything from his retirement savings. He used $250,000, then obtained the past $100,000 through a SBA loan. “We were putting some of our life savings into the company, so there was financial risk,” says Shook,”but we had a good nest egg put aside.”

Shook opened his store in September 2016. “We’re not cash-positive yet, but the company is growing quickly, and we’re predicting to be in the black by early 2019,” he says.

PROS

“Because you are investing your own money when withdrawing from a 401(k), you don’t need to receive a lender’s approval,” states Aliouche. A significant benefit, though,”is you are using tax-free money” to begin, ” he says.

CONS

Though successful, Aliouche says this can be a dangerous funding plan. “If you are using most or all of your 401(k) money, you are putting your life savings at risk,” he says. “If the business fails, you can lose everything.” Another drawback:”401(k) funds are usually spent, so when you take them out, you’re forgoing the prospective returns on this investment.”