Posted on Nov 25, 2011
7 Options for Financing When Buying a Franchise
If you are interested in buying a franchise, the financial aspect will undoubtedly be a top priority. Your first step should be to go through your personal finances and decide, for you, a reasonable amount of capital that you have available to invest. If you are like the majority of people that need to find additional sources of capital, here are a few options to consider.
1. Borrowing money using debt financing.
Most people borrow from one or a combination of the following: commercial banks, government-sponsored bank loans (franchise SBA loans), franchise system loans, home equity loans and credit card loans (although home equity loans and credit card loans are harder to come by these days).
2. Equity Financing.
The primary difference between equity financing and debt financing is that with debt financing, you will have an obligation to pay back the borrowed sum at a stated interest rate, but you will retain control of the business; in equity financing you are giving up a part of the business to an investor or investors in exchange for their financing. The investors may claim some control of the business operations; they will also have some ownership in the assets and potentially will take a share in the earnings. You will not have a set debt obligation to repay as you would with a monthly loan payment to a bank. The investor will be taking a risk as to when and how much of the investment he or she will recoup, as well as whether there will be a return on the investment.
3. Family and Friends.
Some people believe that you shouldn't bring money into any sort of friendly relationship, but if your friends and family have extra funds and aren't willing to lend you money, who will? Friends and family should know your capabilities and want you to succeed. If you're finding it difficult to raise capital from your friends, you may want to sit down and figure out what qualities you have that they feel are less than attractive to invest with. It may be important to figuring out what franchise you would work best with.
In a partnership, you will share the equity of the business (and often times the operating responsibilities) with another person. Although many people decide to go into partnerships with their friends or family, it is very important to maintain a business relationship and formulate a written operating agreement that clearly details the partner's rights and obligations. Both partners must make sure they have trust and confidence in one another, and would feel comfortable if either partner had to run any aspect of the company.
5. Private Equity.
Most private equity firms would not consider funding a single franchise location. They are generally chasing the big deal where the capital requirements are significant, and where the business can generate a very high return on investment. If you are considering a multi-unit franchise deal, a large territory agreement or a high cost investment, such as a hotel or motel franchise, working with a private equity firm is a more viable option.
6. Limited Partnership.
Limited partnerships are usually relegated to specific industries, most often the restaurant business and real estate developments. This type of partnership gives investors special tax advantages and the advantage of limited liability. If the business fails, limited partners can lose only their original investment, any additional capital contributions and their portion of the assets of the firm. Limited partners are usually investors who have little or nothing to say about the day-to-day operation of the business, but who ultimately expect to have their investment plus a nice return paid to them for use of their capital.
Often leasing is part of the package called "franchisor-sponsored financing," and it entails paying a monthly fee to rent equipment, furnishings and fixtures from the franchisor. Usually, there is a buy-out amount at the end of the leasing period, where you have the option of buying the leased equipment or furnishings at pre-arranged price. Leasing has many attractive qualities that can make it a very good option. Although you will pay a greater net amount for the leased equipment, it eliminates the need of coming up with the full amount to purchase the equipment for start-up. Also, in many industries, the equipment will be obsolete in five or ten years, so when your leasing arrangement terminates, you can sign another lease for the newest models. Most leases are long-term and require the lessee to pay all the expenses related to maintenance, insurance, and taxes during the term, and usually requires collateral from the lessee, such as the pledging of assets and personal guarantees.
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