- Franchising is a way to become a business owner without having to build a brand from the ground up.
- The convenience does come at a cost however, with a typical investment of $2.3 million to get started.
- Business Insider compiled this checklist of key considerations, based on conversations with experts, analysis of numerous franchise disclosure documents, and prior reports.
- Visit Business Insider’s homepage for more stories.
Investing in a franchise business is one way to become a business owner without building a new brand from the ground up, but that convenience can be expensive.
A recent Frandata analysis of more than 1,100 brands found the median initial investment in a new franchise business was more than $2.3 million.
In addition, the experts found that even though many franchisees rely on the US Small Business Administration for funding, the limited amount available for guaranteed loans accounts for just 20% of the total needed.
To help prospective business owners navigate the challenges of financing a new franchise business, Business Insider compiled this checklist of key considerations.
The information is drawn from original reporting with experts on the subject, analysis of numerous companies’ disclosures, and review of prior reports from other sources.
Check Item 10 on the Franchise Disclosure Document
As you plan to invest in a specific franchise, you’ll need to carefully review the company’s Franchise Disclosure Document (FDD), which carefully spells out the typical expenses and revenues from operating the business.
One of the first places to check is the section of the FDD called Item 10. That’s where the franchisor presents its official financing options, especially if your business requires a large property or equipment investment to get started.
One of the advantages of franchising for lenders and prospective business-owners alike is that the specific business model and brand may have a track record that can help better estimate the risk of the business.
In general, an established business is less risky than an unproven one, and less risk typically translates to lower borrowing costs and higher chances of securing a loan.
Even so, it costs money to use money. It is always a good idea to consult with a financial advisor about the best way to use your existing resources and determine which new ones are best for your situation.
Franchisors often recommend that you connect with the US Small Business Administration to explore your options for a government-supported loan. In fact, approximately half of all first-time franchisees rely on SBA-guaranteed loans.
The most popular SBA option is the 7a loan program which matches borrowers with lending institutions around the country through its Lender Match tool, and was the model for the $670 billion Paycheck Protection Program.
In addition, the Small Business Investment Company program connects small businesses with private investors who finance a company with debt, equity, or a combination of both.
Talk with your existing financial institutions
It’s also worth getting in touch with the lenders and banks you already deal with on a regular basis. Every bank is different with respect to their small business lending, but practically all are interested in expanding their relationship with current customers.
If you have a credit card, car loan, mortgage, or other account with a lender, it’s worth at least a phone call to hear what your options are.
In addition, bankers have an interest in their borrowers’ success — that’s how loans and interest get paid, after all — and they can provide personalized counseling about building your business.
Consider using your retirement account
Another source of funds (albeit a risky one) for some entrepreneurs is their retirement savings.
Many institutions will help you roll your 401(k) over to start your business (for a fee, usually starting at $2,500). The strategy takes advantage of a tax loophole that allows an account holder to trade their stock holdings to purchase equity in a shell corporation that can go on to invest in the new business.
Another more conventional approach is to leave your retirement portfolio intact and use it as collateral against a loan.
Both approaches share an important drawback, since they take funds from the relatively low risk of a diversified retirement fund and commit them to the fate of a single business. Be careful, and do your homework.
Reach out to friends and family
You’re unlikely to convince a VC to fund your franchising goals, but that doesn’t mean you can’t still seek out private investors to join you in exchange for debt or equity in the business.
Friends and family can be a powerful source of support, and the size of individuals’ investments will likely dictate how formal you’ll need to be. Still, it’s generally a good idea to put everything in writing.
It’s especially important to be clear about whether contributions reflect a loan, an equity investment, or a grant. While grants don’t have to be paid back, you’ll want to be diligent about the terms of accepting loans or equity investments, especially from people whose relationships you value.