Franchise Buying Guide

Franchise Funding Options

You can fund your new franchise in traditional ways--or you can get a little creative.
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Guidant Financial specializes in helping entrepreneurs purchase new franchises using their retirement funds.

You've thought about it long enough, and you've finally decided you really do want to make the franchise leap. You've found the right opportunity, and you're convinced it's a system you'll succeed in. But you'll need financial help to make it happen, and one big question still looms in your head: How hard will it be to sell a lender on the idea? Despite higher interest rates than in recent years, it's a franchise buyer's market out there, says Rick Anderson, general manager at Franchise Finance, a Little Rock, Arkansas, firm that originates loans and leases for the franchise industry. There are fewer buyers, so more lenders are sitting on cash. "You've got better terms and conditions and more finance companies [that are] anxious to talk to you," he says. "It's not that hard to get a loan right now."

That said, prospective franchisees face many of the same hurdles that challenge all startups when it comes to raising the capital to open their doors. A local banker won't necessarily see a venture as less risky simply because it's a franchise. Loy and Melissa Ehlers, both attorneys and former Marine Corps majors, discovered that when they first set their sights on opening a Cold Stone Creamery. They went scouting for ways to raise the $300,000 they'd need, but despite the ice cream retailer's established brand name, local lenders in their hometown of Morehead City, North Carolina, weren't feeling warm and fuzzy. "They looked at Cold Stone as a restaurant, the riskiest venture out there," says Loy, who at the time was working as general counsel and vice president of retail licensing for a furniture chain. With all his experience get-ting other fledgling businesses financed, he figured he'd have a leg up. Says Loy, "The local guys said, 'We love you, but we can't do it. It doesn't matter if you have a 200-page business plan with all the charts and bells and whistles-you've never operated a restaurant.'"

Fortunately for Loy and Melissa, 39 and 41, respectively, Cold Stone had a preferred lender program with Comerica that made the borrowing process a lot easier for newcomers. Comerica was familiar with the Cold Stone system and felt comfortable that its relatively small number of store closings meant the franchisor did a thorough job screening its franchisees. The Ehlerses took out an SBA-backed loan for the first store, then bought four more stores, one of which they've already flipped. Without a track record to point to, the Ehlerses would likely have had to stop at one store, but with the Cold Stone connection, they were able to open four locations in nine months. "I don't care to do that again," Loy jokes.

Cold Stone expanded its list of preferred lenders, allowing the Ehlerses to select a loan from UPS' lending division, UPS Capital. This, along with a guide Cold Stone developed for franchisees detailing lender expectations, has significantly streamlined the borrowing process. Says Loy, "It now takes two to three weeks." With two stores already turning a profit, the other two on track to see black, and a fifth that at press time was scheduled to open in their hometown last month, the Ehlerses have very high hopes for their burgeoning business.

Your Biggest Allies
For first-time business owners, even those with prior management or industry experience, one foot in the door can make all the difference, which is why experts agree that the first stop on your capital hunt should be the franchisor. "A good number of franchisors already have these relationships in place and can direct the franchisee to the lender," says Chris Reilly, president of CIT Small Business Lending Corp., which ranks among the top SBA lenders and has relationships with various franchise companies in the restaurant, early child education and hotel industries, among others. Lenders tend to loosen the purse strings more readily for an applicant who has gotten the green light from the franchisor.

"Usually, if you're approved as a franchisee, you're going to be approved for the loan," says Jeff Elgin, CEO of FranChoice Inc., an Eden Prairie, Minnesota, consultancy.

The SBA program is an especially popular choice for first-time franchisees. Because the SBA guarantees a portion of the loan, lenders can make loans that would otherwise fall outside their risk parameters-and they can offer more favorable terms. "Non-SBA loans are typically five to seven years, [but] the SBA-backed loan is 10 years, or sometimes longer if you're buying real estate in the transaction," says Bernie Siegel, president of Siegel Capital, a national franchise and small-business lending service in Bala Cynwyd, Pennsylvania. "What I like about 10 years is it reduces your monthly payment."

It made sense to Bernard Brophy, too. A Wall Street refugee, Brophy, 46, had worked for 20 years as a commodities trader before he was downsized at Goldman Sachs and left to think about what to do with the rest of his life. After meeting with a franchise consultant, he decided his future was in another type of commodity: dough-nuts. He approached the Dunkin' Donuts franchise, which approved him for a three-store deal and promptly directed him to the SBA. "Without experience in fast food, it made the most sense to go that route," says Brophy. He was approved fairly quickly by CIT, which has a long-standing relationship with the national franchise. With the loan, he financed the purchase, architectural fees, construction costs, equipment and inventory expenses for his store in Medford, New York, which opened in May. He also opened a second store in Lake Ronkonkoma, New York, in August, and he's planning a third store for Nesconset, New York.

The only downside to SBA loans, as both Brophy and Loy Ehler acknowledge, is that the higher fees associated with government-backed loans make the capital more expensive overall. "That's a trade-off we're still making today," says Loy. "Opening four stores in one year doesn't lessen your risk profile. We've basically had to say we're going to accept the higher interest rates so we can get these stores open. We'll come back and refinance when we can show the banks proof that this [business] really works."

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This article was originally published in the January 2007 print edition of Entrepreneur with the headline: Show Me the Money.

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