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How do I finance a franchise?

Article Overview: How to finance a franchise. Part quoted from various franchise experts all across the USA. Canada will benefit from learning from the successes of the USA franchise industry.

Free Download - How do I finance a franchise? By Michael Somer

How do I finance a franchise?

Put franchising on the list of credit-crunch victims. Money for franchise start-ups and expansions is getting harder to come by. Fewer lenders are financing the businesses, and those that do so are being increasingly picky about whom they will bankroll. That has left many borrowers turning to other sources of financing. More people are seeking out loans from the Small Business Administration, which are partially guaranteed by the government, making them less risky -- though some lenders participating in the program are tightening their lending criteria as well. And some would-be franchisees are even tapping retirement funds. The shakeout is partly due to the mounting defaults by franchisees who got in during good times, perhaps short-changed themselves on working capital and then, when the economy faltered, couldn't cover their loans. "Lenders just don't know what the future will bring," says Robert Snelling, president of Honor Capital Group of Plano , Texas, a financial intermediary between franchisees and financial institutions.

Who's In-and Out

Cautious lenders are less likely to throw money at newer franchises these days. Banks are favoring those with brand names, businesses that aren't seasonal, and, therefore, don't have highly fluctuating cash flow, as well as those that have a solid core of long-term operators. Ventures with only a smattering of locations are being bypassed, in part because they lack proof that they can do well in all types of areas or fluctuating economic climates. For would-be entrepreneurs who do get financing, unsecured loans are relatively rare. Even those with good credit may have to crack their retirement nest eggs to come up with enough cash to make a deal work. "The first thing we want to know is, 'How much cash do you have? Any outside income coming in?'" says Rick Anderson, general manager of Franchise Finance of Little Rock, Ark., a company that originat es loans and leases for the franchise industry. Mr. Anderson says if borrowers have substantial cash, "we'd recommend they put more money into the deal -- maybe 40% to 50%, and we'd finance it conventionally." If they aren't flush, he says, they still may have to contribute at least 20% along with collateral -- perhaps just enough from a retirement account to cover the down payment to qualify for an SBA loan. Brian Colburn, managing director of franchise finance at Butler Capital Corp., a commercial lender in Hunt Valley, Md., says that the "only bank loans I see being made to new franchisees are if a person has established other relationships with a banker, or has previous experience, or is a local figure in the marketplace. The average Joe, 99% of the time the bank will turn him over to an SBA office."

Government Backing

Indeed, with banks becoming more tight-fisted, the SBA is becoming the place more would-be franchisees are turning to. "It's what the SBA was created for, to provide access to capital for small businesses who can't get it through conventional means," says Christine Reilly, head of small-business lending at CIT Group Inc., a New York-based finance company. According to Ms. Reilly, CIT has recently "made some changes" to its underwriting criteria for franchising in order to reduce its risk exposure. She declines to say what those changes are. The standard SBA loan for franchisees is known as the 7(a), which is issued by a bank or other qualified lender, and partly guaranteed against default by the government. Because of that backing, such loans are seen as relatively low-risk. SBA loans include those for short-term working capital and equipment, which often have a five- to six-year maturity; and real-estate loans, which can run for 20 years or more. Desp ite the current tight-money situation, "we expect to have adequate funding to meet demand for fiscal '09," says James Hammersley, director of the agency's loan-programs division. About 10% of all SBA loans go to franchisees, with the size running between $250,000 and $500,000, although the maximum is $2 million. Most of that money is earmarked for franchise entry fees, improvements or working capital. Even so, the program is feeling a bit of the crunch. Mr. Hammersley says about 300 of some 4,000 bank participants around the country have reduced their SBA lending activity. He also suspects that many bankers still in it are asking for more collateral. Borrowers must be creditworthy, typically contribute some equity, and are expected to repay the SBA loan out of the franchise's cash flow. "You need to have your own blood, sweat and tears in the business," Mr. Hammersley says. Many SBA loans carry fluctuating interest rates. While the actual rate is negotiated between the bank and the borrower, it's subject to SBA maximums, which are tied to the prime rate. While a low rate may be attractive initially, if borrowers can't generate enough business to cover their payments, "they could be in a bit of a bind," says Mr. Snelling at Honor Capital. "I get a lot of calls from individuals with SBA loans who want to refinance them," he says. "They might have gotten in at 8%, and now the rate has gone up to the high 9s or 10s." For at least one big SBA lending participant, Wells Fargo Bank, a unit of Wells Fargo & Co., it's still business as usual. "We are not tightening up," says Thomas W. Burke, senior vice president of the bank's SBA lending unit. Nor, he adds, has the bank changed its credit criteria. Last year, Wells Fargo closed 209 SBA loans to franchisees and "year over year we're up," he says. Wells Fargo concentrates on lending to service- and restaurant-industry franchisees -- both first-timers and established multiple-unit operators. Interest rates are market-d riven and terms depend on the specific deal, Mr. Burke says.

Helping Out Veterans

Another government lending program involves the Department of Veterans Affairs. The program, called Patriot Express because of its relatively fast approval time, makes loans up to $500,000 to active-duty military preparing to transition to civilian life, as well as to spouses and survivors of veterans. The loans feature the SBA's lowest rates. In a spinoff of that, at least one franchiser is offering financial assistance to disabled veterans who want to start a franchise. At Little Caesars Enterprises Inc., the initial $20,000 franchise fee for a store is waived for disabled veterans, and these franchisees get a 10% discount on equipment, plus about $18,000 to help open the business. "Their first food order -- dough, sauce and cheese -- we give them for free," says David Scrivano, president of the pizza franchiser. Other vendors also contribute. There's about $68,000 in total aid. A few other franchisers offer internal financing to the general populati on. One is Dwyer Group, which franchises a half-dozen home-and-auto service concepts including Mr. Appliance and Glass Doctor. The Waco, Texas, company will finance up to 70% of the typical initial $42,000 fee. The interest rate -- currently at 9% to 12% -- is based on the franchisee's credit score. Rates "may seem high," says Robert Tunmire, Dwyer's executive vice president, "but they're not putting their homes up as collateral or anything like that." Dwyer also gives a 10% discount to franchisees who pay cash.

Retirement Funds

There are many franchise finance options available.The banks are starting to lend again. The future looks bright and franchisors are gearing up for a great year in 2011.Now is the time to think about franchise ownership.

Michael Somer for Coast to Coast Franchise LLC

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About the Author: Michael Somer
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Hello, I am a recruiter for quality franchises based in North America that are specifically looking to grow in Canada. From Vancouver to Toronto, companies are looking to expand, open new locations and invest in markets all across Canada. I am happy to answer questions about franchises.

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