In the Money
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You've read the literature, done your due diligence considered the statistics on success, and know a franchise is the way you want to get into business.
But before you sign on the dotted line, answer this question first: Where will you get the money to finance the franchise and royalty fees, inventory and working capital?
We asked five franchisees across the nation how they financed their businesses and came up with some traditional as well as some distinctive solutions to this often problematic issue.
Franchising seems to be infectious, at least for 40-year-old Douglas York. After spending several years as a contractor whose assignments included constructing a number of stores for franchisors nationwide, he decided to get involved in the finished product. Joining forces with his wife, Frances, a licensed cosmetologist, York purchased a Great Clips franchise in Jacksonville, Florida.
"When we got into Great Clips, you could do three stores in two years [as a discount package]," says York, who opened the allotted stores in June 1998, December 1998 and this April, surpassing his commitment with a fourth location in July.
The father of three had to come up with $120,000 for each location and decided to go with the nonbank lender his franchisor recommended. "Textron Financial gave us a loan based strictly on equipment without a ton of paperwork," explains York. "I did talk to banks, but they couldn't offer anything better than Textron, and with Textron, I didn't have to put up my house [as collateral]."
To open his first store, York secured $60,000 from Textron by submitting two years-worth of tax returns and his personal savings to complete the $120,000 investment. "You shouldn't finance yourself to the hilt," York says. "You have to leave yourself a little room to maneuver."
Friends, family and your own resources are typically your first options when it comes to financing a business. This was particularly true for Paula Bush and Christina Domecq.
Domecq, who started her New Horizons Computer Learning Center in White Plains, New York, in May 1998, now employs 35 people and projects $2.3 million in sales for this year.
To achieve this high level of success, the 22-year-old entrepreneur had to first tap the family coffers for the $500,000 start-up cash the franchisor required.
"I tried to get an SBA loan, and they flat out told me no because I was too young and didn't own a house," says Domecq, who began honing her entrepreneurial skills at age 16 while working for her father's wine and spirits distribution company.
In addition to the SBA, Domecq approached banks and even a loan broker, with similar results. So she turned to her family: an aunt, a grandmother and her dad. "They loaned me the money, and I'm paying them back with interest at the prime rate," says Domecq.
But Domecq admits convincing her father to ante up was no easy task. His major concerns? "I was young, and I wan't a business major in college," she says. What finally convinced him was Domecq's carefully researched, 120-page business plan and the savvy management team she had assembled.
Instead of accepting her family's money on a handshake arrangement, Domecq got a lawyer to create loan papers for each relative. "That's not because my family isn't close," explains Domecq. It was simply to keep the transaction professional.
Paula Bush also went to a relative for the money she needed to start her Pressed4Time dry cleaning and shoe repair pick-up and delivery franchise. Unlike Domecq, however, Bush doesn't have to repay her mother the $12,000 she borrowed. But that doesn't mean she went to the "Bank of Mom" unprepared. "My mother has always been my mentor and friend, and when I decided to go into business for myself in 1997, she was supportive both emotionally and financially," says the Methuen, Massachusetts entrepreneur.
Bush explained to her mother what she wanted to do and showed her her business plan. "She was never concerned about being repaid but asked questions about how I was going to be paid by the customers. I could easily answer her questions, because I had asked the same questions myself before I made the decision to invest." In addition to showing her mother a business plan, Bush also had to check the laws governing how much money her mom could give her as a gift without paying a penalty.
Bush's gamble paid off: The 54-year-old former sales rep was able to start drawing a salary in only her third month in business and is currently generating sales of $12,000 a month.
ABCs of SBA
Once a retailer, always a retailer could be aptly be called the them of Brian McDowell's life. After spending more than two decades progressing from the lowliest clerk position at Kmart at age 16 to president and co-owner of Michael's Stores Inc.'s 17-store Canadian division. McDowell began contemplating other paths. "I looked at Subway and an oil-lube place," remembers the 41-year old, who left the art-supply company when he and his partners were bought out.
During his search, McDowell ran into a friend who had purchased a collectibles franchise called Country Clutter. "It seemed like a lot of fun. You could purchase merchandise whenever and wherever you wanted as long as it fit the motif of the store," he says. He liked the idea so much, he's developing not one, but two stores simultaneously. "I arranged to get the Glendale, California, location, and while that was going on, Orange, [California,] store came up."
McDowell provided about one-third of the start-up investment, approximately $300,000 per location, himself. The remainder came in the form of an SBA-guaranteed loan.
And although he'd heard the horror stories associated with SBA loans, McDowell's experience was good. "Obtaining the loan was no more difficult than I thought it would be," he says, crediting the smoothness of his application process to his decision to use a loan broker. "She did a lot of the work and knew where to shop [the loan]."
McDowell's strong credit report and years of retailing experience were also important factors in his favor, as was Country Clutter's solid business history. McDowell eventually pledged a certificate of deposit as collateral for one store and his home for the other.
His advice to prospective franchisees? Put yourself in the banker's shoes. "What if you had $200,000 and someone wanted to borrow it? I would want to know a heck of a lot about them and how they were going to pay it back!"
Financed by an Angel
You might think finding an angel investor for your franchise would require divine intervention, but Denver entrepreneur Barney Rudden knows what it really takes is connections.
It was a formula my dad had used for a long time," says 28-year-old Rudden of the interent plus return-on-investment combination has used to entice 15 angels to invest a total of $300,000 in his first Colortyme rent-to-own franchise in 1995. "I didn't try other routes because I was just out of college and didn't have an established credit history or any of the other requirements [for a traditional loan]."
But Rudden did have a father who had been in the rent-to-own industry more than two decades. More important, his dad had friends who were willing to take a chance on a Young Turk with a college degree and six month's experience under his father's tutelage. "I also met quite a few people through my wife, who works at a mortgage brokerage in Denver," says Rudden.
After all his campaigning and presentations, Rudden had assembled a group of investors comprised of older family friends and thirty-somethings who liked the idea of backing a young entrepreneur. Acknowledging that the combination of 40 percent interest in the store coupled with guaranteed annual interest payments of 12 percent, paid monthly, was an unusual incentive, Rudden says the package had to be attractive to overcome the reluctance people might have had because of his youth.
To sweeten the pot even further for interested investors, he put interest payments in an account in their kids' names. "So 14 years down the road, their children's college tuition is paid," says Rudden. Among the other attributes of his package are a concrete exit strategy and the first right of refusal to invest in additional locations.
Although he liked the formula for his first two stores, Rudden decided to make a change when he opened his third store in Hemet, California, this past April. He scaled back to four investors and added third-party financing. "I'm changing the formula so I won't have as many investors," says Rudden, who is convinced he couldn't have opened his stores any other way. "Now I only need to raise $100,000 instead of $300,000."
Out With the Old
Why are fewer franchisees turning to traditional commercial loans for assistance? For one good reason: Obtaining a commercial loan to finance a franchise is as easy as finding the proverbial needle in a haystack. Banks are looking for a collaterized loan, and typically in a franchise, there's no real estate involved; it's a leased facility," explains Kirk Fullerton, senior vice president and manager of the SBA lending group at Dallas-based Compass Bank.
Banks want businesses to have three basic qualifications, according to Fullerton: reasonable financial strength and good personal credit of business owners, as well as quality projections. Consequently, says Fullerton, "they have a problem with a start-up on the front end." He adds that most banks are only willing to go three years on a loan without a government guarantee--bad news for franchisees, who typically look for terms of seven to 10 years.
When it comes to collateral, Fullerton says banks want a proven cash-flow stream, and even with the backing of a franchise system, there are still the issues of mismanagement and an unprofitable market.
Consequently, if you want a non-SBA loan from your local bank, be prepared to supply strong collateral that guarantees the bank repayment in case your business fails.
This article first appeared in the Fall 1999 issue of Entrepreneur's Be Your Own Boss