The Basics of Financing your franchise or Small Business

Let’s face it, starting a new small business or franchise is going to have some startup costs. Some areas to be considered might include retaining professionals such as accountants, advisors, and attorneys, along with marketing and advertising costs, hiring employees, buying machinery or other equipment, maintaining physical space and buying insurance- it all seems to add up quickly! With this in mind, here are a few thoughts on financing your franchise or small business the best way possible.

Financial options

The first of the financial matters to consider are your personal assets, such as IRAs, savings, securities, land, stocks, and bonds. If you are able to meet your startup expenses yourself, you will not have to pay fees and rates associated with getting a loan, though you may not want to risk everything you own. In general, the possibility of getting a loan accepted rests on your willingness to back up your request with some collateral. Most new businesses must depend on some type of loan to get started, so taking time to choose the one that best fits your situation will cut down on time, future frustration, and increase your chances of getting a loan.

Types of loans

Some home-based small businesses need only a minimal amount in order to buy some equipment or a starter inventory. These businesses may benefit from microloans, which are short-term (usually a maximum of six years) loans of anything from a few hundred dollars up to $35,000. Many states, and the Small Business Association (SBA), have programs that connect small business hopefuls with interested investors. Larger small businesses may need more funding to get their proposed businesses up and running. These require loans from banks, credit unions, and other lending institutions.

Some new business entrepreneurs, such as minorities and women, can get unsecured loans up to $500,000 with no collateral through special programs offered by business financing groups. For everyone else, a business loan can be secured through the following programs:

• Most small business loans through the SBA are granted through the 7(a) Loan Programs, which can lend as much as $750,000 and are obtained through local lending institutions. These loans are partially guaranteed by the SBA and are usually used for asset purchases, working capital and leasehold improvements.
• The SBA CAPLines Programs provide lines of credit to small businesses to provide working capital for loan repayments and daily cash flow.
• The SBA 504 Loan Programs are an example of a larger and more long-term option. These provide up to 90% financing and range from $1.5m to $10m with up to 25 years to repay if they are for real estate and up to 10 years for equipment and machinery.

Lending criteria

Lending institutions will look at your DSCR (Debt Service coverage Ratio) which is the indicator of how much of the business profit will be available for loan repayment. Another factor that lenders use is the Loan to Value (LTV). This is a look at the value of the collateral that you may need to secure a loan in relationship to the amount of the loan. This can be a backup option used only if the primary payments from the business profits cannot be met. In some cases, this can be used as the entire basis of the loan.

The applicant’s responsibility

To get a small business loan, you must bring information to the table. Be sure to bring a sound business plan if you are starting a business of your own, or the FDD (franchise disclosure document). These documents must include cost of renovating an established building or a new building and surrounding site, fixtures, furniture, equipment, expected salaries, inventory, and working capital. Make sure you understand and can present your financial projections, including an outline of your management skills, past successes and future goals. It’s also important to include résumés of everyone associated with the proposed business, including yours and those of any partners or associates.

Common mistakes to avoid

Many new small business owners fail to secure large enough loans. Having a realistic overview of how much funding will be needed is paramount. This means getting a loan large enough to have funding that will last until the business can be up and running and turning a profit. A good plan includes a sound prospectus of day-to-day expenses and cash flow, plus expenses needed when the business will not be bringing in any profit.

Other times new business owners, do not have a complete understanding of the extent to which their finances will actually be their own responsibility. Some fail to find out if their loans have an extension option or the ability to refinance if a future situation calls for it.

If you are ready to take the leap and start a business of your own, be sure to take the time to get a really good look at the financing part of the endeavor, including possible unexpected costs, and don’t hesitate to get advice from professionals such as those at the SBA.

Darren Jamieson is the Technical Director of Engage Web and writes for Minuteman Press on franchising in the U.S. and throughout Canada, Australia and his native United Kingdom. He has extensive knowledge of the franchise industry, and of running a business, having helped many franchise clients through Engage Web.