Printer-friendly version
Alternative Franchise Financing Can Close the Gap
Franchising World June 2008
Buy a franchise with retirement funds and other untapped resources. Nearly every franchisor or broker has a “one-that-got-away” tale about a would-be buyer whose financing landed just a few thousand dollars short of the capital necessary to close the deal. Thanks to the current credit crisis, franchisors may soon have even more of these stories to tell. The ease with which borrowers once secured both home- equity and SBA loans has devolved into a protracted tug-of-war, and franchise sales are feeling the sting. In light of today’s lending constraints, however, some nearly- forgotten funding opportunities are being rediscovered and are coming to the rescue. Once covered by the dust of obscurity, these alternative funding methods are suddenly looking much more attractive. Some of these options may be familiar, while others are virtually unknown by sellers and buyers alike, yet they all offer the possibility for a vital injection of capital. Here are some alternative franchise funding solutions that may make a few more dreams come true and close the gap between “the one that got away” and “open for business.”
Retirement Funds Investing retirement funds into a business without taking a taxable distribution or incurring penalties is one way thousands have used up to 100 percent of their retirement funds to purchase a franchise. This funding method is growing in popularity, and those who have launched businesses using this strategy are getting the word out about this once nearly-unknown funding method. Taking a loan from an employer-sponsored retirement account, a 401(k), 403(b), and so forth, is possible with certain qualified plans. Taking a loan from a personal IRA is not allowed. Employers can choose whether or not to offer loans to employees via the company’s plan. If the employee takes a loan from these funds and then quits his job, he will likely be required to pay the loan back immediately. Note that interest paid on a retirement account loan is not tax deductible. Taking a distribution from a retirement account before retirement age is an emergency measure many business buyers have resorted to. Unfortunately, early withdrawals (before age 59 and-a-half) carry a 10 percent penalty. Additionally, because retirement account distributions are taxed as ordinary income, they can push account holders into a higher-tax bracket. Using of a retirement-account, business-funding strategy as outlined in the item accompanying this article is one way around this dilemma.
VetFran Program
Private Loans Every day, Web sites such as www.prosper.com and www.lendingclub.com match hundreds of lenders with borrowers. These types of user-friendly sites enable borrowers to secure funding from an aggregate of smaller lenders who sometimes lend as little as $50.
Partnerships (and de facto Partnerships) The difficulty in this scenario when it comes to franchise purchases, though, is that the majority of franchises require all owners of the business to be involved in the franchise, including personal guarantees and participation in all training. For franchisors, something worth considering during the current credit crunch is the relaxation of requirements surrounding owner participation and the allowance of outside investors into the franchise with only minimal, if any, participation.
Unsecured Loans A signature loan is one that is not backed by collateral and is, instead, granted based on the borrower’s credit, income and ability to repay, hence the higher rates and fees. Some potential franchisees are willing to take the financial hit to fund a down payment or a portion of a franchise purchase. Needless to say, these loans are particularly difficult to secure in today’s economic climate. Qualification requirements usually include very high credit scores, current employment and no recent credit delinquencies. A signature line of credit is similar to a signature loan, but its advantage is that it doesn’t require collateral. The qualification requirements, however, are similar to those of signature loans. Because the credit line allows clients to borrow funds up to the credit limit, the borrower only pays interest on the outstanding balance. Not only can credit lines help with the initial franchise purchase, but they can provide an emergency back-up for operating capital. Franchisors who familiarize their brokers and representatives with alternative methods such as these, give potential franchisees a great advantage. Franchise candidates may be sitting on untapped capital simply awaiting discovery. David Nilssen is CEO and co-founder of Guidant Financial Group. He can be reached at 888-472-4455 or ceo@guidantfinancial.com.
There are a few ways people can utilize funds from their retirement accounts, such as 401(k)s and IRAs, to help capitalize their franchise purchase. Each option comes with tax implications, so it’s important that potential franchisees deal with qualified financial professionals to determine the best method for their unique situations.
While the majority of franchisors are aware of this program, it’s easy to forget that potential buyers may be unfamiliar with the plan. The number of veterans has increased significantly since troops began returning from Afghanistan and Iraq. Under the Veterans Transition Franchise Initiative program, franchisor members of the International Franchise Association agree to provide qualified veterans with exclusive financial incentives. Through the VetFran program, veterans can acquire a franchise at a discounted rate. Visit the IFA Web site, www.franchise.org, Programs and Services, for the latest information on this program.
Private lending no longer sits in the hands of questionable lenders or the wealthy elite. Today’s private lending is a rapidly-growing, legitimate enterprise that, thanks in great part to the Internet, has attracted lenders and borrowers from the ranks of the everyday citizenry. This type of lending has the potential to be beneficial for both lenders and borrowers. Personal lenders find it easy to beat the interest rates of lending institutions, while borrowers can secure leverage without having to meet nearly impossible qualifying standards.
A partnership can provide capital for a cash-strapped franchise candidate and it can be formed based on a variety of arrangements. Some franchisees obtain funds or loans from an outside investor in exchange for an equity stake in the business, a percentage of profits, an attractive interest rate or a combination of these and other business deals.
Unsecured loans can be extremely expensive due to high-origination costs and unusually-high interest rates. There are two kinds of unsecured loans:
