Thinking about buying a franchise? If so, you’re not alone – franchising is a booming sector, with well over 1,000 brands to choose from. Becoming a franchisee is a popular way to jump into business ownership.
While there are low-cost franchises you can get into for as little as $5,000, if you want to be part of a name-brand national franchise (McDonald’s and the like), you’ll often need to invest $500,000 to $1 million. Buying a franchise is often the biggest investment a person will make in their life, beyond their house.
The biggest question franchisees ask: “How am I going to pay for this purchase?”
There are many ways to get money to buy your franchise. Here’s a look at the seven most common ways entrepreneurs fund a franchise purchase. I’ve organized this list by level of risk, from most conservative to riskiest.
1. SBA-Backed Loan
One of the most popular ways to get business funding, a Small Business Administration (SBA) loan is a tried-and-true method of borrowing for a business startup. Why? The SBA is often familiar with the franchise chain you’re joining and will consider it along with your financial history. The SBA partners with many banks, so it can help you find the best loan. Financial institutions love SBA loans, as they have another entity to turn to if you default.
2. Find Partners Or Investors
It’s a myth that entrepreneurs launch alone. Many buy businesses with partners, especially if they bring relevant expertise to the table for franchise operations. Using partner money lessens your risk. Similarly, you may find investors looking to reap rewards in a proven franchise concept where they stay behind the scenes. Buying a franchise with partners or investors is a two-edged sword: You put up less money and decrease your risk, but you’ll have to share the profits with your backers.
3. Equipment Loan
If your franchise requires an expensive piece of equipment to operate — say, giant beer-brewing tanks, a pizza oven or a small fleet of trucks — an equipment loan could get you up and running. There are specialized lenders who focus entirely on this area. Because equipment loans are secured by a physical asset, they can be fairly simple loans to obtain. On the downside, if you can’t make the payments, the equipment gets repossessed — and that could put you out of business.
4. Franchisor Financing
Some franchise brands partner with lenders to help their franchisees get started. When franchisors form close ties with a lender, it usually means favorable rates and a fast-track to loan approval.
5. Personal Loan
When all else fails, you can always go to a bank and get a personal loan, but only if you have good credit (one reason some turn to crowdfunding). Risks mount here, because if you default on a personal loan, it will affect your credit rating and ability to borrow in future, likely for years to come.
6. 401(k) Rollover
Here’s a method of buying a franchise that’s increasingly common, even though it risks your retirement fund. Many franchise buyers come from corporate jobs and have a 401(k) retirement plan. In a move the IRS calls ROBS (for Rollovers as Business Startups), your new franchise creates a 401(k) plan for employees. Then, you transfer the funds in your old 401(k) into your account in the new business’s 401(k). Once there, the funds are borrowed back out to fund the launch.
If you have a fat 401(k), there are many specialized lenders who can help you set up a new retirement plan for your franchise and roll over your savings. But be aware that the IRS takes a dim view of ROBS, and has been investigating their legality for over a decade, threatening to disallow them and force entrepreneurs to restore the funds to their retirement accounts. If you go this route, make sure you consult an expert, as your rollover scheme may come under scrutiny.
7. Tap The HELOC
If you own a home and have equity built up, you could borrow against that equity to buy your franchise. Typically, that’s achieved by taking out a Home Equity Line of Credit, or HELOC. What’s to like? Rates and repayment schedules are usually good. But there’s a serious dark side: If you don’t make payments on your HELOC, you could lose your home.
Why Not Pay Cash?
Looking over all these funding options, you may be wondering: If I have the money sitting in a bank account, why not simply pay cash for my franchise?
You may be surprised to learn that few entrepreneurs purchase a franchise for cash, even if they could. The reason comes back to risk.
If you pay cash for a franchise, all your money is tied up in the business. Often, it won’t earn a return for the first year or two while the business ramps up.
By contrast, if you borrow or use investors/partners, you can diversify and invest some of your cash elsewhere. This puts less of your total net worth at stake in a single franchise purchase, a smart move that gives you more options.
As you can see, there are many ways to go when you want to get money to buy a franchise. Weigh your options carefully, and choose the one that’s the best fit for your situation.