How to Finance a Franchise
Amanda: All right. On our last episode of “Franchising with Purpose,” we’ve talked a lot about these terms that we keep going around it, right? A glossary of terms. We talked about the FDD and franchise agreement, the difference between franchise speed, royalty. And I know, a lot of times, there are used interchangeably, but there are two very different terms which is a great segue into what we’re talking about today.
So, you know, we’ve been on this journey for a while now. We’ve talked about business ownership versus being an employee, and what that looks like, it affects, right? For me, we’ve talked about franchising with purpose, right? What is my purpose here on earth? And what do I wanna do to give back and to make a difference in my community? And how can I do that while earning a living and paying down debt and doing all of the things that a franchising affords or owning a franchise affords me the ability to do? Well, let’s talk about getting started because there’s a lot of options out there. If I don’t have that cash in the bank, what are some other options that are available to me?
So there’s lots of things, you know, Small Business Administration, retirement rollover. And we will talk about these, traditional bank loans, venture capitalist, personal savings, investments, family, friends, all that kind of stuff. So let’s start with the first one which is this SBA, Small Business Administration. What, you know, as an option, and we’re gonna keep it super high-level today. And now, we’re gonna talk more and dive into some options in upcoming episodes. But how can I finance my franchise through the SBA?
Mike P: The SBA is an invaluable resource, first and foremost. And they’re there as you look to seek ways to come up with capital. They’re there to help you build a business plan so that it makes sense as you talk to various lenders out there, you know, not only short-term, but long-term business planning, and then other resources they bring to the table. When you look at statistically, at the end of 2018, there was 30.2 million small businesses out there which accounts for about 99% of our U.S. economy. That’s strong. And when you think about that. Who helps them through that process? There’s a variety of different sources, but one of them that the government has set up is a Small Business Administration which, as I said, help you provide financing.
They themselves don’t provide financing, but they provide the guidelines and basically the underwriting to structure your business plans towards getting financing from a third-party lender. We use a number of lenders, and hopefully, in the future, we’ll have one of them join us to talk a little bit about private lending as well as, you know, some of the SBA loans that they do business with. And so I look to the SBA all the time, and many of our franchise owners do to obtain finance. And if you combine that, we’ll talk, I’m sure, later about grants. Grants are dollars, they’re made available that you don’t have to repay, you know, which are equally important as you look at…come up with capital. So I know you’ve had a number of experiences with the SBA over the years as well, so…
Mike M: Yeah. And I was chuckling to myself while you were talking about the SBA because everything you said was dead-on. I mean, they’re there to help, they’re there to get loans done. But, you know, they have one interest, and that is making sure they get the money back, right? That’s ultimately what they care about. So they put you through a heck of a process, a vetting process financially, a business plan, the company itself. They want to look at everything because if I, the government, are gonna loan money out, and I’m gonna guarantee to the bank, I’ll just say 90% of that loan, so the bank that you’re going through, the lender you’re going through isn’t on the hook for the bulk of it, the government is. They better hope that you’re the right person, that your plan’s right, that the company that you’re investing in is right because they want to make sure they get their 90% of money back, with interest.
And so for some people, you know, and it depends, there are some businesses that wouldn’t be eligible for SBA financing because the loan is too small, the risk is too high. You know, you see a lot of that sometimes with startups where, you know, there’s no known commodity that the government can attach that 90% number to. But yeah, I mean, it’s a great resource if you’ve got the right company, you’ve got your finances in place, and a good business plan. It’s a great resource to look at. And they’re willing to lend to the right people. Like, that’s the beautiful thing about the SBA. They will absolutely lend if the circumstances are right.
Mike P: All right. And as you’ve said the process, the business plan, and all the metrics, that criteria they set up have to be met. They can’t be almost met. They have to be met or they’re not gonna go on the hook with that potential liability. They’re not philanthropic. They definitely want their money back.
Mike M: Yeah, they’re not the good guys in that regard.
Amanda: We’ll get to those a little bit later on down the list.
Mike M: Okay.
Amanda: All right. So let’s talk about…I think probably one of the most common that I’ve heard, at least, is retirement rollover business startup. What does that look like as a potential option to someone looking to purchase a franchise?
Mike P: That’s a great question. I mean, there’s a lot of folks that are thinking about business that has equity, maybe in their 401(k) that they can roll that over to start up a business and use that as capital. I think most people don’t realize that it’s there or obviously they know it’s there, but that they could use it to start their business and the benefits that go along with that as they’re searching for capital because the first thing…you know. We’ve talked about in previous episodes is that’s why small businesses fail. They’re undercapitalized, and you need to have access to that. So that is the basis to form, you know, the necessary capital that you need to start your business. If you are looking at it…I know if you have a 401(k) that you want to start a business, I can start sharing. Right, Mike? But if you wanted to use that, you know, you could talk to your administrator and start to work towards rolling those dollars into four specific prescribed, starting your own business.
Mike M: Yeah, so the three ways I’ve heard it, you know, retirement rollover, rollover business startups, 401(k) rollover. It’s all the same thing, right? It’s leveraging your 401(k). Unlike the SBA loan, you’ve gotta feel really… first of all, I’m a big fan of that, that process, because for people that, you know, may not be eligible for SBA loans, if you’ve got the money in your 401(k), you can get a loan. I’m sorry, not a loan. You can use your retirement to fund the business. You don’t have to go through the exhausted process that the SBA has, that you may never get approved for, for SBA loan. So as long as I have enough money in my retirement, I can use this. They help you set up a corporation, and then they get you rolling over. There is rules of raise because remember, you’re talking about early withdrawal of retirement funds that have to be paid back.
So there’s a lot of things much like the SBA that you have to be aware of when you’re doing a retirement rollover process. But you also have to be very confident in your ability to succeed because it’s your money you’re taking out of your retirement. That if you fail, you’re throwing that money away. You can foreclose on a business and loan and maybe it’ll kill your credit, but you know, they may wanna attach to your future earnings. It just doesn’t hurt you the same way…It hurts you, just not the same way as draining a 401(k) and not having the ability to replenish that because, you know, 57 years old, then I can’t get back that money that I may have rolled over. But it’s a great option for those who don’t want to go the traditional bank route, bank, you know, loan route, or the SBA route because the money is there.
And I can pick corporations to help me set up what I need to do, walk me through every step. And the one thing about the rollover is the plans, I think all of them, if not most of them, not all, require you to take a salary out of that rollover money. So, you know, you’re taking your money, and then you’re paying your salary out of that, and you’re putting dividends back in to a plan. So it’s kind of interesting in the way it works, and I’m very high level because I don’t know all the nuances of it. But those are some of the cool things I think about rollovers.
Mike P: And there’s some of the lenders that we work with will have a conversation with you about that, so they can outline a specific criteria to make sure that you’re fully compliant with the…you know, so that you’re not only accessing your capital but maximizing your tax advantages. And being able to, as Mike said, you know, as you take that salary, you know, get the benefits, the pure benefits of the dollars that you’re rolling over.
Amanda: Mike, you mentioned traditional bank loans. I think that’s the first thing that most people think of, “If I need money, I’m gonna go to the bank, and I’m gonna get a loan.” So let’s talk about the good old-fashioned bank loan.
Mike P: The good old-fashioned bank loan. Yes. You know, it’s unique. Not every bank is gonna lend out on businesses because some people may or may not agree that owning your own business could be considered a high-risk situation. So lenders, you know, some banks are less likely to wanna or have an appetite to wanna lend, but there are community banks out there that understand the value of small businesses. And, you know, again, with some of the lenders that we’ve dealt with in the local community banks, they’re certainly well in-tune with small businesses and the requirements. And if you were to use guidelines and Small Business Administration’s guidelines and put together a business plan, I think that business plan would stand up to the requirements planning any local lender.
But that is certainly a source. You know, besides commercial banks, there’s also the community banks and then credit unions that offer, and they’re there to support small business owners. And they will help you create a business and almost, in addition to your business plan, they’re gonna work with you to make sure there’s another layer of support to help you grow your business because they have a mutual interest in seeing you succeed…
Amanda: Yeah, yeah, absolutely.
Mike P: …which is a called a repayment of the loan, right?
Mike M: Right on.
Mike P: So yes, that’s one lender. I’m sure you can comment on that, Mike.
Mike M: Yeah, very valid points. It’s not the most popular way because it depends on the bank because they’re assuming 100% of the risk unlike SBA where they’re not. And so it depends on the area of the bank, and what they want to do, either to grow their own business and their, you know, profit loss statement? And, you know, what they think they want in the community to stimulate, you know, community businesses. And so, you know, it’s an opportunity if you get to the right bank in the right circumstances to have them, you know, provide a traditional business loan. But it’s not the most common way today to do it, but it’s an option.
Mike P: Yeah, you know, we had talked at one of our real early episodes about having a board of directors, how important it is as a business owner. And one of the people that may be on your board of directors would be your local community bank loan officer, right, who would be, you know, meeting with you on a regular basis and helping you craft and adjust your business plan as necessary. But it also helps you have access to additional capital. So working closely with them, not only there’s accountability factor there, but there are also a liquidity factor there where you might be able to get a little bit additional capital and help pay down debt structured plans, to not only pay debt, increase your equity, or even expansion. They can be part of that process. And one of the things that they can do…I know that some of the local banks here were excited about the success of the small business people in the community, and how they play an integral role in making that happen.
Amanda: All right. So one of the other options that we talked a little bit about and again, super high-level financing option is venture capitalist.
Mike M: VCs are not really prevalent in, like, the small business type of environment where, you know, I’m just looking to buy a franchise. You don’t see that, but more if I’m looking to be a master or area developer, something much larger that would be attractive to them. I don’t think…
Amanda: Nothing on a bigger scale.
Mike M: …venture capitalist are, yeah, looking for the one individual franchise business. They’re looking for your masters or area development and then they want…And they look at the industry, and they look at the growth. And so if you’re gonna go that direction, I mean, it’s possible. I don’t know that it’s relevant for the individual person who’s looking to buy a franchise.
Mike P: Right.
Amanda: Good to know.
Mike M: Mike, any thoughts about that.
Mike P: Well, no, I agree with everything you said. I think they’re more, you know, if someone were buying a territory, like a state or multiple states, they would fund that. There are maybe some small investors out there that are willing to invest some dollars that they wanna see growing. And maybe, for example, there might be an investor that has some money in an investment money where it’s not getting the high returns. Maybe they can get a better return on a business loan, but it’s not gonna be quite the amount that maybe a venture capitalist…I mean, we’re talking about investing in millions of dollars where, you know, you might only need $200,000, $300,000, something like that.
Mike M: We call those people angel investors, right?
Mike P: Yeah.
Mike M: They’re the ones that don’t mind making a smaller investment with a little bit of return on the interest. That if they think you’re a good bet and the company and industry are solid, that they would, you know, fund the business to you. You get your money through the angel investor. They invest it, you run it. They make their money back, and then they’re out. A lot of times, they’ll do that. They’ll do that with multiple people and multiple industries. And they just make their percentage off the loan, and that’s how they get their money.
Mike P: Yeah. Typically, some of those angel investors may be part of your board of directors as well. I hate to keep going back to that. What they do not only…Obviously their vested interest, but they wanna see you grow. They actually wanna be a cheerleader and see that investment grow because as your business grows, so does their investment in the [inaudible 00:15:48] initial returns. So that’s very important.
Amanda: So I think the next one on the list here is pretty self-explanatory. But we got personal savings or personal investments are always an option for financing a business. Anything you care to elaborate on with those?
Mike M: Not common. I mean, it’s an option. But, you know, I mean, some people… There are people out there that don’t like debt. And, you know, when I get a loan, I gotta pay that debt back. If I’m financially sound, and I see a good opportunity, could I use my personal savings and my personal monies to buy a business? Absolutely. I would just say it’s not very common.
Amanda: What would you say is the most common form of financing?
Mike M: SBA or retirement rollover.
Amanda: Okay. What about family and friends? Is that something that you see typically or what does that look like as an option?
Mike P: I think that is an option. It’s the investors. They’re silent partners or maybe not so silent partners. If their family members, you know, it makes for interesting holiday meals. But that is an option. You know, in this year, we have a GoFundMe page. You might wanna try to set that up, but I don’t know how likely that is. But it occurs. I don’t see that as a large…If we see someone like that, they’re usually a partner in the business. They’ve become, you know, a vested partner in the business, but not my family is just reaching in and saying, “Hey, you know, here’s a pile of cash for you to use and invest.” Because in that situation like any other investor, they’re gonna want returns. And then you’ve got a really…If you’re gonna do that, I would suggest that you formalize it, have the documents drawn up by a legal counsel to make sure that everything is outlined so you don’t run into uncomfortable dinner conversation.
Mike M: Yeah. And for clarity on the family and friends, it’s not like they’re taking their personal savings and turning it over to you. What you typically use family and friends for, you see a lot where you have parents that want to help their children get into business. And so they’ll go on a loan. They’ll partner as Mike said. They’ll partner on the loan. And they’ll leverage their credit or their net worth as a way of helping a loved one, a family member, or friends to get into business. So when you talk about family, friends, typically that’s what you see. They’re just leveraging what they have because you don’t have it, and they’re banking on you. And then to Mike’s point, they’ll get their return out of it based on the arrangement you set up based on interest that you’re paying on that loan to them.
Mike P: Yeah. Just a one quick follow-up on that. You know, there are parents who want to provide a gift now, you know, to their children, and they could do that. I would suggest that they talk to their accountant if they’re gonna do that, so both parties are able to maximize tax advantages. That is an option. And typically, that’s your money. You could kind of like do what you see fit.
Mike M: Right, right.
Amanda: All right. Lots of great financing options. I’m sure that there are more out there that we didn’t talk about. But again, I want to let our listeners know that if you have any questions… Mike, I want to pick your brain more about angel investors. It’s not something that I know a ton about. And I would like to learn. So listeners, have any questions or wanna learn more, you can feel free to tweet us @GriswoldFran, happy to answer those questions for you and connect and learn more about it. Thanks, both, so much for being here. As usual, great information. I’ve learned a lot. I hope our listeners have, too, and look forward to doing it again.
Mike P: Thanks, Amanda. Appreciate it.
Mike M: Yes. As always thanks to you and to our loyal listeners.