Funny Money

OK, there's nothing funny about money--but when standard franchise financing doesn't happen, it's time to start using your entrepreneurial wits.
Magazine Contributor
12 min read

This story appears in the January 2001 issue of Entrepreneur. Subscribe »

Franchise Fee: $8,300
Initial Inventory: $20,000
Uniforms: $300
The Satisfaction Of Being Your Own Boss: priceless
For everything else, there's MasterCard. Not to mention American Express, Discover, Visa and a slew of other credit cards. Take it from Bernie Mexicotte, former vice president of what is now Bank One. En route to buying a Luxury Bath Systems franchise in Flint, Michigan, Mexicotte slammed right into a financing roadblock. His money was tied up in two other businesses, and despite his excellent credit, lenders were unwilling to grant him a loan to invest in a then-unknown franchise concept. He was even rejected by the bank he'd worked at for 21 years.

Drawing on the power of plastic, Mexicotte racked up $75,000 in cash advances and charges. In all, he used 27 credit cards to cover start-up costs and eight months of operating expenses.

Detoured by similar roadblocks, many franchisees map out alternate avenues to financing-some on their own, some with counsel, but rarely with quite as much risk as Mexicotte. Let's meet some of the more creative treasure hunters:

  • Todd Recknagel, 37, founder and managing partner of a mezzanine banking firm. Recknagel enlisted support from four wealthy investors who guaranteed the bank would be repaid its $500,000 loan for a five-unit Blimpie International Inc. franchise in western Michigan.
  • Tom Stringer, a 39-year-old chemical engineer with Kimberly-Clark. Stringer was a clueless prospective franchisee with fledgling franchisor Computer Doctor until a consulting firm groomed and guided him toward a $115,000 loan to open his Indianapolis franchise.
  • Jo Ann Foley, a laid-off machinist. With the help of a college counselor, the 49-year-old and her husband, Robert, 56, got a bank that had already turned them down to finance their $27,000 Curves for Women franchise in Galax, Virginia.
  • Mark Teears, 39, a project manager for a software developing company in Southern Maryland. Teears was rejected by bank after bank-not to mention venture capitalists-on his bid for $60,000 to open a The Cleaning Authority franchise in Raleigh, North Carolina. Thanks to a helpful trio (a consultant, an existing The Cleaning Authority franchisee and a sympathetic banker), Teears broke through his financing roadblocks.

Paul DeCeglie, a freelance business writer in Los Angeles, is a former reporter for American Banker and Journal of Commerce.

Getting A Loan

More money than ever is available for franchise financing, and it's coming from an unprecedented number of sources, ranging from community banks and nonbank lenders to tailored franchise finance companies and brokers. At the individual level, however, seeking money to buy and operate a franchise can be a long and frustrating experience. Some franchisors facilitate the process by helping start-ups with business plans, loan applications, alliances with lenders or even direct loans. Most do not. Newer and smaller franchise systems, in particular, lack the resources to provide such assistance. Nevertheless, whichever franchise you select, "before beginning a search for outside funding, ask what programs the franchisor has in place to help franchisees secure funding," recommends franchise veteran Rick Anderson. The general manager of franchising of Little Rock, Arkansas-based Franchise Finance says his company works "with a number of franchise systems that are preapproved. When a prospective franchisee comes to us for funding, we don't have to underwrite the franchise system, so the loan is processed that much faster. Many finance companies have similar relationships with franchisors."

In the absence of such relationships, search the Internet for franchise financing sites, banks, finance companies and equipment leasing firms. Many provide a wealth of information online; some even accept loan applications and spell out their qualifications. What does Anderson look for in a loan application? "We consider their credit report, net worth, liquidity and outside income," he says. Franchise Finance likes borrowers to have 30 percent of the purchase price in cash as well as some assets and backup income during the initial stages of their businesses.

Other lenders are similarly inclined. Consequently, when Teears solicited the Raleigh branch of BB&T Corp. for a franchise loan two years ago, he was denied. "They weren't impressed by my numbers," he reports. Teears was looking at The Cleaning Authority's $22,000 franchise fee plus twice that amount in start-up and operating costs. He had only $17,000 in cash and mutual funds, and was leaving his job to move to Raleigh. All signs pointed to a compatible and profitable union between Teears and The Cleaning Authority, based on testing, research and counsel provided by The Entrepreneur's Source, a franchise consulting organization. But the bank wasn't convinced, and neither were the many others he tried. Nine months of searching, waiting, calling and persisting produced nothing.

After some additional coaching from The Entrepreneur's Source, the frustrated Teears once again descended on BB&T, where he had developed a cordial relationship with a new lending officer. He went armed with documentation-including impressive financials from an existing The Cleaning Authority franchisee. It worked. "They granted a $60,000 loan with the first six months as a line of credit, so I only paid about 13 percent interest on funds drawn," recalls Teears. "I still have $20,000 of that, which I might use to expand my territory."

Need a helping hand getting your capital? Read Financing Your Franchise for a fountain of sources.

Persistence And Creativity To Get Funding

Persistence was the key to Teears' finally getting funding, but Recknagel used creativity to fund a group of Blimpie stores and grow quickly. The minimum start-up cost for Recknagel's five-store chain was half a million dollars, and he didn't have it.

Recknagel inquired about loans at two Michigan banks. "Both turned me down flat as soon as I said the word 'restaurant,' " he remembers. "Raising $500,000 for any venture is difficult at best; getting such a large loan to finance restaurants is next to impossible."

Recknagel, then managing partner of the mezzanine firm Liberty Bidco in Southfield, Michigan, abandoned his search for a loan. Instead, he devised a strategy to convince a bank to provide a $500,000 line of credit. Plan in hand, Recknagel approached four friends who'd invested in other companies; each had a net worth of more than $1 million. He asked them for written limited guarantees-two for $100,000, two for $200,000-in return for 32 percent of company stock, divided on a pro rata basis. Recknagel explains: "These guarantees allowed me to walk into a bank and say, 'We need $500,000 to do this. You'll be first secured on a quality franchise and a growing restaurant. Because we don't know what kind of debt service repayment we can provide or when we'll build the second restaurant, third, etc., we look to do it interest-only, drawing on a line of credit. And we'd like some flexibility in repaying the debt in order to accommodate seasonal cash flows.' "

In short, Recknagel arranged for financing that posed no risk to the bank and limited risk to the investors. In addition to the $600,000 backed by the four guarantors, he provided an unlimited guarantee as the main partner. He further rewarded the guarantors by paying them a 1 percent royalty, also pro rata.

The bank agreed to the arrangement, providing the funds at 0.5 percent over prime. Since that experience in 1994, Recknagel has opened eight Blimpie locations, repurchased the investors' 32 percent interest in the company and refinanced $750,000 in debts with a loan backed by the SBA at a fixed rate of 8.5 percent.

You heard it here first! Read In The Money for true stories on how entrepreneurs got their capital.

Seeking Approval

Before beginning any money hunt, pro-spective franchisees should seek approval from their chosen franchise systems. Once an application is accepted, the franchisor usually provides an abundance of information, the most important of which is contained in the UFOC. (For more on the UFOC, see "Presidential Secrets") The information in the UFOC and other materials will help you determine your overall cash requirements and immediate borrowing needs.

If your franchisor is small or new, be prepared to do more legwork, as Tom Stringer did when he sought financing for his Computer Doctor franchise. "It's a small franchise. It was even smaller in the fall of 1999 when I started looking into it," Stringer relates. "They don't have the resources to provide guidance and fill-in-the-blanks forms. I had to do a lot of work that applicants with other franchises [are often spared]."

Lacking business experience, the chemical engineer had no idea what to do or where to begin. While adjusting to married life in his wife's native Indianapolis, he paid Computer Doctor $20,000, launched a location search, worked on a business plan and completed the first week of training. "They did refer me to some banks, but nothing came of it," says Stringer. "I had no idea where or how to pursue financing."

Realizing he was "in the dark," Stringer sought enlightenment through the Business Resource Store in Carmel, Indiana. The entrepreneurial counseling firm "not only helped me analyze what I was doing, what my goals were, how I would do business and with whom," he explains, "[but] they also coached me on operating and marketing the business, helped me develop a high-level business plan, estimated my financial needs and connected me with [CIT Small Business Lending]." The firm also saw the loan through to conclusion. "They had incentive: Their fee [3 percent of the loan amount] was based on my successfully getting financing," says Stringer. CIT provided a $115,000 SBA-backed loan at 2.5 percent over prime. "I have to pay them $2,000 a month, but knowing it will be repaid in seven years makes it easier to live with."

Dangers Of Using A Credit Card

Luxury Bath Systems franchisee Bernie Mexicotte repaid his $75,000 credit card debt in 24 months, though at higher interest rates than those paid by Stringer. Despite his success using plastic, Mexicotte warns, "It's not for everyone. Use credit cards only if you have the ability to manage that kind of debt. Otherwise it's too easy to get jammed up. Too many Americans use their credit cards to the hilt, get a second mortgage to pay off that debt and go right back and max out their credit cards again. You can't do that in business."

Mexicotte admits he still uses his credit cards, "constantly juggling balances from one card to another to avoid interest or to take advantage of a $10,000 deal at interest rates of 2.9 or 3.9 percent. But I'm diligent. I watch the due dates carefully. A better strategy would be to develop personal relationships at a local bank before you need a loan. When you get somebody who believes in you, that will carry you well beyond your needs."

But relationships don't always work. Jo Ann and Robert Foley had developed banking relationships at BB&T, where they'd been loyal customers since they married 27 years ago. But when they applied for a $27,000 loan to open a Curves for Women franchise, the bank dragged its feet. "In 1996 I lost my job at Proctor Silex when they sent the jobs to Mexico," says Jo Ann. Neither she nor Robert, a textile mill worker, "had any business experience, college education or assets to speak of," she says. "Besides, [the bank] didn't want to take a chance on an unproven franchise."

Unacquainted with other types of financial institutions, or any options, for that matter, the couple followed the bank's suggestion and met with a local community college counselor. "He helped us put a business plan together. We took it back to the bank, but they still weren't satisfied. They wanted all kinds of documents and had us fill out forms. They even demanded titles to our cars and insurance policies," says Jo Ann.

15 Fast Franchise Financing Tips
1. Talk to your franchisor before searching for outside financing; get approved or pre-qualified.
2. The most common source of start-up capital is friends and family. Use them.
3. Seek out lenders who understand not just small business but franchising as well.
4. Be totally honest and upfront with lenders. Hide nothing. Be prepared to explain everything.
5. Neatness counts. Fill out your credit and loan applications clearly. Typed is better.
6. Don't weigh down your loan application with documents.
7. Don't exhaust your liquidity by paying off outstanding debts before filing a loan application. Lenders want you to have capital.
8. If you lack liquidity, find a partner with money.
9. Consider equipment leasing to conserve start-up capital and improve the appearance of your balance sheet.
10. Keep debts and expenses to a minimum. Many business owners take on too much debt, forgetting that cash flow must pay that debt.
11. Consider buying used equipment, furniture, vehicles, etc.
12. Let your fingers do the walking on the Internet before wasting time, energy, gas and phone calls. You'll find useful information. Some sites even allow you to file loan applications online.
13. Don't overlook angel investors and venture capitalists. Many have cooled to the high-tech sector and are seeking alternative investments.
14. Avoid dipping into your retirement money or your kids' college funds. Any start-up-even a franchise-is a risk.
15. Don't give up. Some Web sites offering financial information, assistance and/or access to funding:

Business Lenders
Center Financial Leasing
Commercial Capital
The Entrepreneur's
The Finova
Global Financial
Lobo Financial

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