Whether you write a personal check, use the equity in your home, use your 401K money or get a commercial loan, one way or another, you’re financing your franchise. Financing it the right way is important to your long haul success. It could not be as critical as choosing the best locations, but it’s close.
Broadly speaking, in financing your franchise business, you’ve three basic options:
Option I: Finance it out of your own pocket, either by writing an always check from savings, cashing out retirement assets, or some other means,
Option II: Take out a loan secured by your own personal assets, such as for example an equity loan or an SBA loan, or
Option III: Take out a commercial business loan for franchise financing.
Each option has its pros and cons. The most effective option for you is going to be predicated on many different factors, including the goals you’ve for your new business. One option may be best if your goal is to open just one location, another if your goal is to open several in confirmed time frame security franchises . What follows is just a discussion of the various options and how one might or mightn’t be the most effective one for you. It is our goal to help you make the most effective decision possible, predicated on your overall situation and on your goals. Alternatives for Franchise Financing Option I: Finance it out of your own pocket If your objective is to open only 1 location and you’ve the liquid cash to open it and get it to profitability, this is not a poor choice. You will lose the interest earned on your money, but avoid the interest cost of borrowing. If you intend to open more than one location and have the resources to get all of them to profitability, again, this may not be a poor choice.
However, when you have the resources to open the initial location, and want to rely on using cash flow from the initial one to open the second, third, etc, be careful. Remember, when you have cash in the financial institution or equity in your own personal assets, you are able to always use that for working capital or expansions later. If you intend to rely on commercial financing anytime, financing the initial one is what offers you the best flexibility.
That’s the downside of this option. Having your own personal money tangled up in a business limits your flexibility in the future. You may or might not be able to take advantage of a future opportunity as it pertains along. Many books are available that discuss the value of using OPM (Other People’s Money) in opening and growing a successful business.
Option II: Take out a loan secured by your own personal assets This Option provides greater flexibility than Option I. Your liquid assets remain liquid giving you the capability to respond as needed to changing business requirements. The web, after tax difference between interest earned and interest paid could be low making this a feasible alternative to Option I.
The downside of this Option will come in two forms: (1) tying up the non-public assets you pledge as security, and (2) the actual, all-in cost of the financing.
Tying up your own personal assets limits your decision and flexibility in the future. As an example, we recently funded a 2nd area for a specific franchisee. He had applied for an SBA loan for his first location using his home a security. He knew the lender was also filing a lien against his first location but no one thought this would have been a problem since we planned to secure our loan with only his new location.
What we discovered through the title search was that when the original lender filed their lien against the franchisee’s business, they listed the positioning they certainly were financing and included the phrase “all future locations” in the lien filing. Those three little words meant that any and all locations this franchisee would open anytime in the foreseeable future were likely to be considered security against his original loan! We were eventually able to resolve this but needed to negotiate a subordination agreement with the original lender.
The lesson here is usually to be cautious about what the lender actually uses as security on the loan because it may limit your options in the future.
In terms of the actual, all-in cost of the financing, this can be quite a complex subject. Unfortunately, some lenders want it that way. They will quote a low interest rate however not the points and loan fees involved. They won’t make an effort to educate a borrower on the differences between variable rate financing and fixed rate financing. They won’t fully disclose most of the charges which can be incurred during the life of the loan.
The lesson listed here is to get everything in writing and review it with a trusted advisor. Most reputable lenders will issue a proposal or term sheet which includes detailed information about payments, fees, terms, security, etc.Read More