Q: I don't have enough money to start the franchise operation I want, so I'm going to need to get financing for the balance. I'm wondering if I should go to my local bank to get the money or if there's a better method for me to use. What's the best way to proceed with this task, and are there any special programs that can help?
A: This is an important topic for just about anybody who wants to start a franchise business. It's also a topic that's frequently misunderstood. You should have a good working knowledge of the likely parameters of financing that apply to you and also the best sources of information about available programs.
Most people think that getting a loan to start a business is just a matter of talking to a bank. After all, isn't that what banks do-loan money to people who need it? Would-be entrepreneurs figure they'll explain their reasons for wanting this particular business, outline the projections for how much money the business will make, and then the banker will loan the money based on those projections. The loan will be secured and then paid back from all the assets and profits of the new business. Problem is, there is zero chance this scenario will work.
If you walk into any bank and tell them that you want a loan to start a new business, you won't get any money unless you can completely collateralize the loan through your own personal assets. In other words, if you have cash, stocks, home equity and other semi-liquid assets that could easily repay the loan if the business defaults, the bank will probably lend you the money. On the other hand, if this is the situation, you don't really need a business loan.
If you have sufficient personal collateral to secure a loan for the amount you need-especially if it is in your home equity-the easiest and cheapest way to get that loan is to establish a line of credit at the bank for the amount you need. Don't even discuss a business start-up with the banker. Whenever a banker hears that you're going to start a new business, it raises multiple red flags and creates issues that will just slow you down and cost you more money.
Let's assume you're not financially strong enough to take this approach. You're going to need help. The other options potentially available to you include government-sponsored programs from agencies like the SBA , non-banking loan sources and lease options. Each has many variations, but the common denominator is that they'll be willing to take more risk, so you're chances of getting money will be better. To offset the increased risk, the dollars you get from these sources will also be more expensive (in terms of fees or interest rates).
Two common misconceptions about the SBA are that it loans money and that it's willing to do so on an unsecured basis. Neither of these assumptions is correct. The SBA has programs where it will work with lending sources like banks to guarantee most of a business loan's repayment. This is done because the bank will not loan the money without the guarantee. To offset the risk of making such guarantees, the SBA charges fees to the borrower. The SBA also has stringent requirements in relation to security that must be met before it will agree to issue the guarantee. This may still be your best option, but keep in mind that it's not automatic.
As a general rule of thumb, you'll need to have your own cash available for at least 30 percent of the total investment required for the franchise business. You can also expect that any lending source will probably require personal guarantees that will effectively pledge all your assets to protect any loan.
The best source of information about options that might be available to you is the franchisor you're interested in joining. The franchisor should be familiar with the costs associated with each option and the likelihood of you being able to obtain financing from any particular source. Many franchisors have already set up programs with selected financial sources to facilitate rapid funding of their franchisees. In this case, the franchisor should be able to walk you through the process with a minimum of hassle for you. The first thing you should do-once you're fairly certain you've found the franchise right for you-is to request this information from the franchisor and start looking into your options.
Jeff Elgin has almost 20 years of experience franchising, both as a franchisee and a senior franchise company executive. He's currently the CEO of FranChoice Inc., a company that provides free consulting to consumers looking for a franchise that best meets their needs.