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.
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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 in franchising,
both as a franchisee and senior franchise company executive. He is
currently the CEO of FranChoice
Inc., a company that provides free consulting to consumers
looking for a franchise that best matches their needs. He can be
reached at jelgin@FranChoice.com.
The opinions expressed in this column are those
of the author, not of Entrepreneur.com. All answers are intended to
be general in nature, without regard to specific geographical areas
or circumstances, and should only be relied upon after consulting
an appropriate expert, such as an attorney or
accountant.