By Bob McQuillan, Vice President of Franchise Development, Hand & Stone Massage and Facial Spa
Franchisors are usually pretty strict about their monetary requirements. Regardless of the total cost, the investment is bound to be substantial. In addition to the franchisee fee, a franchisor will want to ensure you have a specific net worth, as well as available liquid capital.
So why bother with funding if you’re expected to have a hefty bank account? There are several reasons.
Reasons you need franchise financing
The biggest mistake entrepreneurs often make is underestimating the amount needed for working capital. Your franchisor will provide you with the average capital needs when opening your business. The franchisor plays such an important role in your business plan, and estimating the right amount of working capital will be pivotal in the success of the business.
While there may be minimum net worth requirements, you don’t want to invest the entire amount of equity you have in your primary home in your business. Net worth is one thing - liquidity is another. You also need to have enough available working capital to get you past break-even, or the point at which your business turns a profit. This may take a few months, in which you need to pay for things like construction, rent, equipment, supplies, systems, and payroll. If you decide to open additional locations, you don’t want all your liquidity tied up in your first business. By obtaining financing, you can give yourself a steady paycheck while you establish your location.
Finally, while you may have the funds to cover your entire investment, with today’s low interest rates, investing your own capital in other markets and leveraging your worth by borrowing may be a better choice. You won’t have to worry about liquidating investments that are likely to perform well long-term in favor of your business. Financing can allow you to take advantage of the best of both worlds: long term cash investments and an investment in your future.
What is a franchisor’s role in securing your funding?
According to Rocco Fiorentino, President and CEO at Benetrends Financial, the investment level in a franchise is substantial, yet in a lot of cases, franchisors haven’t identified a financial partner that can help their candidates get funding and open locations. Unfortunately, many franchises are great at sourcing vendors and suppliers, but believe financing should be the responsibility of the franchisee. He says:
“If you went into a car dealership and they didn’t have Ford Motor Credit or GMAC financing, and you said, ‘I love the Mustang! How much is it?’ and they said, ‘$35,000,’ and you say, ‘Great, can I lease it for finance it?,’ and if the dealer said, ‘Oh, I’m so sorry, we don’t do any of that, you’ll have to go to your local bank, tell them all about my Mustang, and you come back with a $35,000 check and I’ll give you the keys,’ obviously, they wouldn’t be selling many Mustangs. We relate this to franchisors because they’re asking candidates to invest $400,000 and in most cases, even if they had $400,000, they’re smart enough to know money may be cheap enough [to borrow]. There should be a way to leverage the investment.”
Your franchisor should have systems in place to help you qualify for the funding you may be seeking. Look to see if they have financing partners that can help shorten the process of qualifying for funding. These systems, like Benetrends Rainmaker Plan®, use a variety of options to find the perfect balance of financing for your unique needs and situation.
Still, it’s best to be aware of all your options. The most common are retirement rollover plans, conventional loans, and the Small Business Administration (SBA) loans. One of these financing options is likely to work for your funding needs.
Rollovers as Business Startup
When you sign up for a retirement plan via an employee 401k, 403b, or IRA, you have the option of investing in various products. Most people choose a combination of stocks and bonds, relying heavily on mutual funds. The stock market isn’t your only option, though. You can use your retirement funds to invest in a variety of things - including your business.
These Rollovers as Business Startups (ROBS) are beneficial because you incur no taxes, penalties, or debt on the amount you use for business purposes. This allows you to save up to 40% you would otherwise pay out in early withdrawal penalties - not to mention the interest or origination fees you need to pay for a traditional loan. This also differs from a 401k loan, since you do not need to repay the rollover; it’s simply another form of business investment, which differs from investing in publicly-traded stock. Of course, you can also use this as the cash injection requirement for a traditional loan or SBA loan if you need additional financing.
The majority of businesses requiring less than $200,000 are funding through ROBS, though plenty of higher-investment businesses are funded fully or partially with this option.
A conventional loan can be provided by a bank or lender. The interest rate on a conventional loan depends on several things, such as:
- The length of the loan. A longer term may mean a higher rate.
- Your credit rating. The better your FICO score and other credit metrics, the better your rate and the more you may be approved to borrow.
- Any collateral. An unsecured loan is more risky to lenders, and therefore you may not be able to borrow much and will pay a higher interest rate. If you have business or personal assets to use as collateral, the lender will see you as a more worthy risk.
Unfortunately, the amount you can borrow is at the discretion of the lender, and banks are extremely risk-averse. They are unlikely to take the risk on a new business venture - either a brand new concept or company, or a new business owner. While multi-unit franchise owners who are looking to leverage their collateral and expand to new locations may be able to work with a bank with which they have a pre-existing relationship, normally banks are simply unwilling to risk extending conventional loans to small business customers.
U.S. Small Business Administration Loan
The U.S. Small Business Administration Loan, or SBA loan, was developed because risk-averse banks weren’t extending conventional loans to small businesses. Since each small business owner needs to be qualified to receive credit, and each business concept needs to be evaluated for its creditworthiness, conventional loans are a labor intensive option banks aren’t willing to engage.
With a specific SBA loan called a 7a loan, up to 75% of the amount of the loan is backed by the federal government, lessening the risk for banks when they lend money to a startup venture. In addition, banks normally ask for around 25% as a down payment, making their risk almost nothing. For most businesses, these loans can range from $50,000 to $5 million.
The CDC/504 SBA loan program is specifically designed to assist with real estate purchasing or renovation, eliminating the need for a mortgage or construction loan, since the capital for purchase, renovation, and completely establishing and running your business can be available through just one loan with one interest rate and one payment. You can also amortize the loan over 7, 10, or even 25 years, with no penalty for prepayment.
A Rollover as Business Startup source of funding can be used to fund the down payment on an SBA loan, making that combination of funding sources common in the franchising and small business space.
One consideration, though, according to Fiorentino, is that your preferred bank may or may not have expertise in SBA loans, which can drag out the process, or they may not be funding your concept. If they’ve already backed two other small business owners with similar concepts, they will likely want to spread out their risk. Meanwhile, 2 blocks down the road, another bank might be willing to do it; however, you won’t know unless you approach that bank individually about the borrowing process.
Securities Backed Line of Credit
When looking for cash to finance a business, or a cash injection needed for a down payment on a larger loan, such as an SBA loan, many people assume they will sell some stocks. This can be a viable option, but selling stocks generates capital gains taxes. Just like with cashing in retirement funds, you need to account for those taxes when you sell stock and use it for your business venture. Of course, you also lose out on future growth for the stocks.
Another option is a line of credit, which uses your stock portfolio as collateral. You can take out this line of credit for 70% of the loan-to-value ratio of your portfolio. You will still own the stocks and gain the benefits of future growth and dividends. You can also borrow at a lower interest rate than with many other products, while historically stocks earn, on average, 8-9% per year, possibly making this type of financing option a no-brainer!
How Hand & Stone helps you secure funding
By partnering with Benetrends, Hand & Stone is able to offer a proprietary program that helps franchisees more quickly qualify for financing and use the best mix of products for their individual situation.
In 2014, Benetrends introduced a $100 million franchise fund, with $10 million earmarked for Hand & Stone Massage and Facial Spa. The program was so successful that Hand & Stone’s fund was recently doubled to $20 million.
Rocco Fiorentino says Benetrends likes the space Hand & Stone occupies - the growing health and wellness marketplace, with affordable spa services becoming even more popular.
“We like the space Hand & Stone is in… the wellness concept has been well accepted in franchises if you look at the competitors. They are all doing really well in the category. So it’s a category that we financial services providers really like, the unit economics. We think there’s a lot of runway left in that category. We don’t think it’s a fad and we don’t think it’s going out of style any time soon… We like the management team. We’ve seen the growth there. So we like the fact that they’re growing and invested in their infrastructure. We took a deep dive into the brand and wanted to understand their real estate site selection criteria. We didn’t have to worry about where in the US they were going to place it; wherever it was, it would be a center that met or exceeded the criteria they set forth. We looked at their marketing efforts - they have their own in-house marketing company. With their recurring revenue model, they certainly can control their destiny.”
Rather than have franchisees go to their local bank and have to pitch the Hand & Stone model, especially in brand new markets that might not be as familiar with the brand, Benetrends has a partner bank that has already underwritten funding for well-qualified candidates. As long as the franchisee meets the specific requirements in their “credit box,” they will be approved for funding within 48 hours. The funding can take the form of any of the above options, with the best mix of funding recommended by Benetrends.
Fiorentino says the one thing he wants potential Hand & Stone owners to know is that, “There’s money waiting for them.”