Five Ways to Finance a Franchise Franchisees share how they pulled together the cash to open their own franchise.

The companies on the Franchise 500 list come with a huge range of price tags. You could open a Jazzercise exercise-class franchise for as little as $2,405, for example, or a Buffalo Wild Wings unit for between $1.99 million and $3.8 million. So once a potential franchisee finds the right fit for them, they have to answer a big question: How are they going to pay for it?

There are many options -- from straightforward friends-andfamily loans to complicated 401(k) investment techniques. Each comes with its own benefits and pitfalls, and, financial experts say, the best one for each person depends on their earning potential, current asset position, how much they have saved, their creditworthiness, and most important, their risk tolerance.

But that all sounds hypothetical, which is why we wanted to see how these financing plans play out in real life. On the following pages, we profile five successful multi-unit franchisees who each paid for their first franchise in a different way. They reveal the up-front costs, the size of their loans, and what they think of that decision today. Then we run it all by E. Hachemi Aliouche, a professor and director at the University of New Hampshire's Rosenberg International Franchise Center, who breaks down the pros and cons for any potential franchisee.

Courtesy of Sport Clips

Finance Option 1 / Personal Savings

When Doug Porter decided to launch a career after retiring in 2015, the San Diego–based Navy veteran, now 62, set his sights on the hair-care industry. "I considered two important factors. One was that this industry was not likely going to be disrupted by the Amazons of the world in my lifetime, and the other was that statistics showed this industry is fairly recession-resistant," says Porter. "People don't stop getting their hair cut when the economy dips."

To buy an existing Sport Clips store in San Diego, Porter chose to dip into his stock-and-bond portfolio for the $200,000 up-front costs. "I knew I wanted to only use personal savings," says Porter, who consulted a financial adviser to survey his funding options. "I had a mortgage, and I didn't want to take on new debt." He was using about 7 percent of his assets, and the withdrawal represented investment gains in his portfolio. He also had health insurance from his then employer, so he wasn't worried about unexpected, catastrophic medical expenses that could deplete his retirement savings.

It worked. His first location was successful, and he went on to purchase four more Sport Clips with the profits and another $50,000 from his savings and his IRA. (Because he's older than 59 and a half, he didn't have to pay an early withdrawal fee.) "I feel I made the right decision," he says, especially since the IRA withdrawal was a small fraction of the account's value. "I wasn't stretching myself."

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PROS

"The best aspect of using personal savings to start a business is you don't have a monthly debt payment, so you don't risk any loan defaults in the event that the business does poorly," says Aliouche. "It's also a great option if you have bad credit and can't qualify for a loan."

CONS

"You're giving up the returns of stocks and bonds, and returns have been high the last few years," says Aliouche. "Also, when you use money from personal savings, you no longer have that cash to lean on for emergency expenses."

Courtesy of Tint World

Finance Option 2 / Friends and Family

Danny Shenko learned about Tint World, a car-window-tinting and automotive-accessories company, while researching potential new business opportunities in 2011, when he was 26. He met the company's CEO, and things clicked. "The franchise was just starting out, but I really connected with the CEO's drive," says Shenko, now 34.

Buying a Tint World shop, however, cost $200,000 -- and back then, he didn't have enough personal savings. He used some wedding gifts, and he and his wife borrowed about $50,000 on credit cards. "Our good credit allowed us to secure zero percent credit card advances that allowed up to 18 months for repayment," says Shenko. To cover the rest, he turned to those closest to him. His best friend offered to invest, but Shenko decided not to go through with it; he worried about harming the relationship if the business went south. Instead, his best friend's sister chipped in $30,000.

"There was some pressure to repay in a timely fashion," he says, "but one thing I know is that in business, you need to take advantage of opportunities and always stay flexible and creative." So he stretched his finances and repaid the money a year and a half after opening. In turn, his friend's sister didn't charge him interest -- even though they'd signed a formal agreement that included an interest rate. Today all is well: Shenko just opened his fourth Tint World, and still has his best friend.

PROS

"If you have a friend who is willing to lend you money, it's a great funding approach in the sense that you get quick access to cash, you don't have to hassle with banks, and you don't need to have strong credit," Aliouche says.

CONS

"If the business tanks, and your friend who lent you the money has financial problems, you may feel responsible," Aliouche says. If you don't feel comfortable with only a verbal agreement, "you could write up a simple recognition of debt," for instance, "I, Jane, borrowed $100,000 from Joe. I agree to pay him back the full amount by December 31, 2020. Signed: Jane" -- or have a lawyer draw up a formal agreement.

Courtesy of Firehouse Subs

Finance Option 3 / Conventional Bank Loan

Shortly after Elliott Goldsmith heard of Firehouse Subs from a friend in 2001, he decided to pivot career paths. "I was hooked after the first bite," says Goldsmith, then a 24-year-old working at a telecommunications company in Jacksonville, Fla.

Goldsmith set out to bring the fast-casual restaurant to his hometown in Greenville, S.C. After he considered applying for a Small Business Administration loan, he chose to open his shop by using a five-year conventional bank loan instead. "The SBA loan just seemed a lot more complicated," he says.

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Goldsmith used a local bank that had already issued loans to the Firehouse Subs corporation. "My lender knew the Firehouse story, so I didn't have to go in and sell him on the concept," he says. His shop opened in 2002.

Now Goldsmith, 41, owns seven Firehouse Subs in the Greenville area. He's used five-year conventional loans, with fixed interest rates, to open each location. He says the company's low franchise fee of only $20,000 has enabled him to expand his business steadily over the past 17 years.

Goldsmith says he would recommend the same loans to other entrepreneurs -- with a caveat. "Paying off a loan in five years can be pretty aggressive," he says, "but if you have the cash flow to structure the payments over five years, I would encourage someone to consider this type of loan." He also encouraged the use of local lenders because "at the end of the day, there is a lot of value to be able to sit in a room with a local banker and review your financials and go over your plans for future developments," he says.

PROS

"If you're trying to grow quickly, using a bank's capital can allow you to do that," says Aliouche. In addition, "the interest you pay on a business loan is tax-deductible."

CONS

With conventional bank loans, "if you default on your payments, you could lose the business, and you could even go bankrupt personally depending on the type of bank loan," says Aliouche. Moreover, "if you have too much debt, it can make it more difficult to obtain another loan in the future." If you have a weak credit score (anything below 650), you might have trouble getting approved in the first place, he adds.

Beth Kaldwell | Two Men and a Truck

Finance Option 4 / Small Business Administration Loan

Nick Roerig and Gordon Shaffer became friends while working at a Two Men and a Truck franchise in Columbus, Ohio. They eventually decided to buy their own franchise, and each saved up $50,000 for the purchase -- but they wanted to buy an existing franchise in Brentwood, Tenn., that would cost more than $500,000. After consulting with a small-business-loan broker, Shaffer and Roerig applied for a $475,000 SBA loan through U.S. Bank, a bank loan that's guaranteed by the federal agency.

"We had no idea what we were getting ourselves into," says Shaffer. The SBA's application process is notoriously protracted, and theirs took four months. "It was very stressful," he says. "There were a lot of moving parts, and it seemed like there was always another piece of paperwork we had to provide." The loan finally came through "at the eleventh hour, right before closing," he says.

When the men were ready to buy a second location, they applied for another SBA loan, this time for $375,000. They used a different bank, and this time it took only a month to get approved. But later, as the men went on to purchase four more franchises, they financed the purchase through the seller. Shaffer says the process was "way easier," taking only about a week.

PROS

If you can't get approved for a conventional bank loan, you may still qualify for bank funding through an SBA loan. "Because the government subsidizes and guarantees SBA loans, they make it easier for people with less money or mediocre credit to qualify," Aliouche says. Interest rates are also usually lower than market rate.

CONS

SBA loans can be complicated. "The application process is very bureaucratic and painfully time-­consuming," says Aliouche. The average SBA loan takes 60 to 90 days (depending on the lender and the size of the loan), but Aliouche has seen that stretch to several months.

Courtesy of Batteries Plus Bulbs

Finance Option 5 / Tax-Free 401(k) Investment

Stan Shook spent 37 years in the gas-and-oil industry. "I built large 401(k)s at both of my employers," says Shook, 58. So when he decided to buy a Batteries Plus Bulbs franchise in Humble, Tex., which would cost $350,000 to start, he wondered if he could pull in part from the $400,000 he had in retirement savings. The answer was yes: Batteries Plus Bulbs provided Shook with a list of vendors that specialize in helping entrepreneurs use 401(k) savings as startup capital -- without having to pay taxes on the money.

Usually, if 401(k) owners withdraw money before age 59 and a half, they get slapped with a 10 percent early-withdrawal penalty, in addition to income tax on the amount withdrawn. But Shook was guided through a financing technique that solves the problem: He created his new corporation, and then that new entity opened a new 401(k) plan. Shook then rolled his existing 401(k) balance into the new plan -- and, because he now controlled the investment options for it, he could use the funds in that plan to invest in the business.(This technique is risky, so don't attempt it without consulting a financial planner and an attorney.)

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Shook ended up not taking everything from his retirement savings. He used $250,000, then obtained the last $100,000 through a SBA loan. "We were putting some of our life savings into the business, so there was financial risk," says Shook, "but we still had a decent nest egg set aside."

Shook opened his store in September 2016. "We're not cash-­positive yet, but the business is growing rapidly, and we're predicting to be in the black by early 2019," he says.

PROS

"Because you're investing your own money when withdrawing from a 401(k), you don't need to get a lender's approval," says Aliouche. An important benefit, though, "is you're using tax-free cash" to start up, he says.

CONS

Though effective, Aliouche says this can be a dangerous funding strategy. "If you're using most or all of your 401(k) money, you're putting your life savings at risk," he says. "If the business fails, you could lose everything." Another drawback: "401(k) funds are usually invested, so when you take them out, you're forgoing the potential returns on that investment."

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