Franchise Funding Options

You can fund your new franchise in traditional ways--or you can get a little creative.

By C.J. Prince

Opinions expressed by Entrepreneur contributors are their own.

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."

Factors in Your Favor

To be sure, banks like hard numbers, and whether you're applying for an SBA loan or any bank loan, you need to know what lenders are after. As always, solid business plans with strong financials and a great credit history are musts. Industry experience, or a related history, is a big plus. But perhaps equally important, says Reilly, is a franchise company with a proven concept. "The lender is going to be focused on how strong the organization is and what kind of support it can give the franchisee," she notes. The stronger the franchise company and the longer it's been in business, the better the loan terms will be, and, generally, the less you'll have to ante up in terms of equity.

If the franchise company hasn't been in business that long or the lender isn't familiar with it, be prepared to sell them on it with strong numbers. "The first contact you have with the lender, you want to impress," says Jeff Rosenfeld, managing partner at Kessev Finance, who recommends providing a detailed explanation of how you plan to save money on equipment and supply arrangements, your research on buying vs. leasing, your plan for hiring and managing employees, your plan for finding real estate and so on. "That indicates you have been thinking about this like a business-person," he says.

It's also a big boost to have a spouse still earning a regular paycheck outside the new franchise. "That way, the lender knows you can pay personal living expenses while developing the business," says Anderson.

That was the case for Howard Taylor, 40, who decided to leave his job as a raw materials planner at Plastipak Packaging to open a Nestlé Toll House Cafe franchise in Novi, Michigan, which is scheduled to open next month. His wife Alisa's job has provided steady income as he's worked to get the franchise going. "[Lenders] consider that a 'soft landing,'" says Taylor. "My wife makes more than I do. So that was even more attractive to them."

Tapping Retirement Funds
With the help of Derrick Skogsberg of FranFund, a Carrollton, Texas, consulting firm, Taylor successfully applied for an SBA loan through Small Business Loan Source, but he was able to take a smaller loan by using his 401(k) funds to partially bankroll the business. It works this way: Taylor rolls over his 401(k) assets of about $100,000 into a new profit-sharing company set up by FranFund, which then buys stock in the new Nestlé Toll House Cafe. "I don't have to amortize that $100,000 over 10 years and am not paying a penalty to access the funds, or the 28 percent income tax on top of it," says Taylor. "That's very attractive."

Some consider it risky to tap retirement assets for a new business venture, but Taylor sees it as a natural fit. "My wife and I did a lot of soul searching about it, to say the least," he says, adding, "In the end, we were willing to take that risk and build equity in something we were managing rather than leaving it up to someone else. My 401(k) is still invested for my retirement-I just have more control over its performance now."

Several companies now offer similar solutions for investing retirement assets into a new franchise, including BeneTrends, Guidant Financial Group and SDCooper Co. If you choose to go that route, show the plan to your accountant to make sure you're not running afoul of any IRS rules. (See "Cracking the Nest Egg" on page 112 for more on using your retirement funds.)

The one big advantage of using retirement assets, say Siegel, is that they're yours. "There's no debt to repay," he says. As for the risk involved, it may not be that different than the risk associated with loans that call for personal assets as collateral. With enough careful planning and due diligence, you can mitigate the dangers, but any business venture is a risk. "And sometimes in life," says Siegel, "you just have to take a risk."

For more information on getting financing, go to's Money Channel.

Innovative Programs

Creative Capital
Some companies have innovative programs to help prospective franchisees get their start. Allegra Network, a graphic communications franchise, helps new franchisees acquire independent printing companies to convert into Allegra franchises. Allegra usually arranges for seller financing, letting the franchisee put down about 25 percent to 30 percent and then pay prime plus 2 percent, on average, over a three- to 10-year period. "The seller functions as the bank," says development manager Robert Miller. "The purchaser [should have] the ability to pay the down payment, support the debt service, pay a royalty and provide a reasonable quality of life [for themselves] while building that business."

Firehouse Subs also offers a deal: Through its American Dream program, successful managers of company-owned stores can purchase an 18 percent share of their store's revenue stream for $5,000. After three years, they can purchase their own franchise, and Firehouse Subs will lend up to $150,000.

Incentives also exist for minority groups. Several hotels, including Choice Hotels, InterContinental Hotels Group and Marriott, have reduced application fees and royalty fees for minority investors.

Cracking the Nest Egg
In recent years, more franchisees have tapped their retirement savings to finance their purchase, thanks to financial solutions offered by firms like BeneTrends, FranFund, Guidant Financial Group and SDCooper Co. For a fee of about $5,000, you can transfer 401(k) or other qualified retirement assets to the retirement plan of a new C corporation. That plan then invests the money to start up the franchise-and you pay no penalty for early withdrawal.

Even if you take out a loan, you can still use your retirement assets as a down payment or a nice cushion until the profits get rolling. David and Laura Mann took out a loan for 100 percent of the purchase price of their first Great Clips franchise in Houston, but worked with FranFund to set aside funds from two IRAs for unanticipated expenses. Since owning the franchise is a part of their retirement plan, David doesn't consider it any more of a risk: "We're just taking a piece of our long-term savings and diversifying."

Inside Deal
One advantage to signing up with an established franchise company is that you're more likely to benefit from third-party arrangements with lenders, leasing companies and other capital providers. For instance, McDonald's, one of the pioneers of third-party lender arrangements, helps new franchisees get lower rates from Chase Bank through the Chase McDonald's Finance program.

Some fast-growing franchises, sensitive to the hefty cash-down requirements that can be a barrier to entry for some franchisees, have struck deals with lenders. Cold Stone Creamery worked with its SBA lenders-Banco Popular, CIT and UPS Capital-to lower the franchisee capital investment. "[Lenders] usually require anywhere from a 25 percent to 30 percent cash injection," says Dan Beem, vice president of profitability for the ice cream franchise. "We've leveraged our brand to get that equity injection down to 15 percent for the first store and 10 percent for any subsequent stores or acquisitions."

Similarly, Minneapolis-based Dunn Bros Coffee has relationships with third-party lenders that let qualified applicants put down only 10 percent to 20 percent of the total initial investment, with a term of up to 10 years.

The Big Question
The first question on the minds of most prospective franchisees is "How much money can I make with one of these franchises?" This question creates a dilemma for most franchisors for two reasons: First, no one knows how well the franchise will do, and second, franchise laws impose tough standards on the performance information, or earnings claims, a franchisor can deliver to a prospective franchisee. The rule is that if a franchisor provides any performance indicators or projected sales/profits/revenue, the information must be laid out in Item 19 of the company's Uniform Franchise Offering Circular. Most franchisors will simply sidestep the question and refer you to their franchisees.

Wait! Your potential earnings, and the earnings experiences of other franchisees, are important subjects. Why shouldn't franchisors be required as a part of the disclosure document to provide at least part of the answer to that question? Why not require franchisors to simply list the gross revenue of all their franchisees in the past year, or give us the average sales? A number of industry commentators have made that point, but the regulators (the FTC and officials from a dozen franchise registration states) aren't convinced. Where, then, can you find some answers to The Big Question?

  • Franchisees are probably your best source of performance information, regardless of whether the franchisor includes earnings claims in the UFOC. They can also give you a vital perspective on other aspects of the franchise. Talk to several franchisees-the financial performance of just one or two may not be representative.
  • All UFOC documents will include extensive information on the total fees and expenses associated with the franchise purchase (see Items 5, 6 and 7); this will give you a great jump on your business planning.
  • A good accountant can help you prepare a break-even analysis and make some reasonable projections for your new business. This financial planning process is at the very core of business planning, and an accountant will be a vital member of your team.
  • Talk to an account manager at your bank if it does a lot of work with small businesses. He or she may be of help in making your financial projections.--Andrew A. Caffey

The Golden Ticket
After begging family, friends and banks for startup capital, are you still strapped for cash? Ace Hardware has dreamed up the Dream Ace Promotion, an enticing contest that might just make your dream of entrepreneurship come true. The hardware and home-improvement company is offering a million-dollar opportunity to the top aspiring individual in the country who can demonstrate leadership abilities, people skills, business acumen and community involvement. The winner will be awarded an Ace Hardware store that's fully staffed, fully stocked and ready to go.

Interested? Apply online anytime during the month of January at After a multistep selection process, the winner will be announced in March and granted ownership of the store in July. "This is even better than a million-dollar lottery ticket because we're giving away a business that has earning potential for years and years," says Paula Erickson, director of advertising and brand development. "We really want those people who are serious about being an entrepreneur to be a part of this competition."--Sara Wilson

C.J. Prince is Entrepreneur's "Dollar Signs" columnist.

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