News Column

Funding a Franchise Startup

May 2001

By Barbara Beckley, HISPANIC BUSINESS® magazine

With a success rate averaging 95 percent, franchising can be a lucrative option for Hispanic executives who want to go into business for themselves. Former banker Ernie Sandoval, for example, has seen his McDonald’s franchise grow into a HISPANIC BUSINESS® 500 company, with 10 restaurants in San Diego.

In fact, it’s an especially good time for Hispanics to consider franchising. “The $350 billion Hispanic market has put recruiting Hispanic franchisees at the top of the radar screen for many franchisors,” says Don DeBolt, president of the International Franchise Association (IFA), an industry trade group.

Unlike other new business ventures, franchises don’t require owners to start from scratch. Getting started still requires money, of course. How much varies with the company. According to the IFA, the average startup investment for eight out of 10 franchises, excluding real estate, is less than $250,000. Almost half require less than $100,000.

A glance through the spec sheets of franchisors listed on the IFA Web site (www.franchise.org) reveals a broad range of figures. Terminix pest control requires startup cash of $18,200 and a total investment beginning at $51,000. McDonald’s startup investments begin at $409,000, and Taco Bell requires a $3 million investment for a minimum of three restaurants.

Where should entrepreneurs look for startup financing?

A majority of franchise startup loans originate with commercial banks and independent financing specialists, or the U.S. Small Business Administration (SBA). Bank of America has created funding pools for minority franchise owners, for instance.

Some franchisors either offer direct financing themselves or help franchisees find a bank or lender. Most have lists of bank and non-bank preferred lenders with which they have good relations. Growing numbers of franchisors offer programs that help women and minorities become franchisees by reducing the financial commitment, says Leon Oldham, Minorities in Franchising (MIF) committee chairman of the IFA.

Following are some specific funding sources:

* The Certified Development Co. is a private nonprofit organization licensed by the SBA to make loans to small and medium-size businesses in need of financing for industrial or commercial buildings, machinery, and equipment.

* Small Business Investment Companies (SBICs) provide equity capital and long-term debt financing, specializing in particular industries.

* Business and Industrial Development Corporations (BIDCOs) provide long-term debt financing to small businesses. They are operated under state programs with federal guarantees, but exist in only a handful of states.

* Community Development Corporations (CDCs) are an excellent resource, according to Mr. DeBolt. There are more than 4,000 nationwide.

The SBA has special funding programs for women and minorities, Mr. DeBolt adds, and other federal and state programs also help minorities with funding.

“Lenders expect the borrowers to provide a minimum of 20 percent to 30 percent down on a franchise loan,” explains Kirk Fullerton, senior vice-president and manager of SBA lending for Compass Bank, an SBA-preferred lender based in Dallas. “That means coming up with $50,000 to $200,000 of your own money, depending on the type of franchise.”

“The ideal net worth is one-and-a-half to two times the loan amount, in liquid cash or available on short notice,” says Rick Anderson, director of the Franchise Division of the IFA and general manager of finance for Arkansas-based Franchise Finance, also a specialist in franchise loans. An outside income, such as that of a working spouse, also is important in qualifying first-time franchisees, he says.

SBA loans are currently the most popular method of financing a startup franchise, according to Mr. Anderson. SBA loans are arranged through general banks and banks that specialize in franchise funding. A portion of such loans is guaranteed by the SBA. In addition, the target franchisor must be registered with the SBA; most well-known franchisors are.

“SBA loans are excellent for people who don’t have a lot of working capital,” says Mr. Anderson. “Interest rates are competitive, first-timers can borrow 80 percent, the terms are generally 10 years, and there’s no prepayment penalty.”

Such factors help keep monthly payments low. Candidates who develop a strong business plan usually are pre-qualified by the SBA.

One of the SBA’s fastest-growing programs is that for 7(a) guaranteed business loans, for amounts of $100,000 or less. It’s known as the low-documentation (“low doc”) program because it has a simple two-page application.

For entrepreneurs who have all the cash they need, equipment loans are a good strategy. The equipment is the collateral, so franchisees can finance 100 percent with nothing down. These loans average five to seven years and usually carry a prepayment penalty. “This can save franchisees about 20 percent,” estimates Mr. Fullerton.

Mr. Sandoval used a seven-year equipment loan from Bank of America to purchase his first McDonald’s in 1983. The prepayment penalty was the only downside, he recalls. When the opportunity to buy two more restaurants arose just 18 months into the loan, Mr. Sandoval had to pay the penalty when he sold his initial restaurant to buy the other two. He recommends negotiating away the prepayment penalty when possible. “You never know when an opportunity will come up to sell or refinance, so you need to be prepared,” he says.

Should first-time franchisees use a regular bank with which they have a relationship or an institution that specializes in franchise funding? The answer depends on whether the bank is familiar with the franchise industry. Franchisees generally have an easier time securing bank loans because they have the backing of an established company with marketplace experience (the franchisor), and franchise loans generally have a lower default rate, says Mr. DeBolt.

Franchise funding specialists often grant the loans faster and save the franchisee money through enhanced collateral, contends Mr. Anderson. “Because we know the franchise system, we can give collateral value to the franchise and the equipment, thus reducing the collateral needs of the applicant,” he says.

“We look at the worthiness of the franchisor as much as the prospective franchisee,” agrees Mr. Fullerton.

Traditional banks that aren’t familiar with the industry have to take time to educate themselves about how a particular franchise works before considering loan applications. In some instances, prospective franchisees may have to come up with 100 percent or even 125 percent in collateral with a traditional bank, according to Mr. Anderson.

Direct financing by franchisors is another option for reducing loan expenses, although not all franchise companies offer it. Terminix will finance up to 70 percent of the initial franchise fee with approved credit. Mail Boxes Etc. will help with up to $40,000 in financing for fixtures and equipment. Blimpie Subs & Salads offers equipment financing.

Franchisor programs aimed at women and minorities can offer substantial savings for candidates who qualify. “Cost savings can range from waiving all or part of the initial startup fee to giving the franchisee a fully stocked store to run on a trial basis,” explains Mr. Oldham.

AFC Enterprises – the Atlanta-based franchisor of quick-service restaurants such as Churchs Chicken, Seattle Coffee, and Cinnabon – offers the PLUS program to help candidates with five years of restaurant experience become franchisees. For qualified applicants, PLUS can reduce the startup requirements for a Churchs or Popeye’s Chicken franchise from the normal $200,000 in cash and $400,000 in net worth to as little as $50,000 and $250,000, respectively.

Whatever funding vehicle a franchisee might opt for, Messrs. Fullerton and Anderson stress the importance of overcapitalizing in the beginning to help ensure success. “Have the money the franchise says you should, and then some,” recommends Mr. Anderson.



Source: HISPANIC BUSINESS magazine


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