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| Your Resource for Wisconsin Franchise and Business Opportunity Information |
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FINANCING |
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So you're thinking of buying a franchise but you're short on funds. You're not alone. Few people write a check for the entire investment and have to seek outside funding. Not only will you need money for the initial franchise fee, but there may be training expenses, construction, equipment, fixtures, advertising and working capital needed. And don't forget, you'll need money to live on while you're ramping up your business. Some
franchises may finance the franchise fee or a part of the total cost. This
is not the norm. If you can't afford the initial investment you'll have to
seek outside sources. The SBA conducted a study on funding of start-ups
business in general. This includes all kinds of start-ups including
franchising. The major funding sources reported are as follows: Personal/family
and friends - 57% Let's explore some of these options: Home
Equity Cash Out Refinance: Investors can put more money in their pockets by tapping into the equity they've built in their home and doing a cash-out refinancing. In this scenario, they can refinance for an amount higher than their current principle balance and take the extra funds as cash. Check with your mortgage lender for current rates. Second Mortgage: Adding a second mortgage to a property can provide access
to home equity funds and/or replace smaller current second mortgages.
Because these loans take second lien position (rather than first lien
position of the primary mortgage), the rates are typically higher. Second
mortgages often allow borrowers to obtain 90-100% of the value of their
home in debt financing. The interest rate will be higher than the option
discussed above. In each case, candidates will need to use a lender and get an appraisal. There are not always upfront fees; if there are, they could be up to 2.5% or more of the value of the home. Interest from home equity loans should be tax deductible. Monthly payments will vary depending on the creditworthiness of the borrower, the amount of collateral provided through home equity and the current market interest rates, among other factors. Retirement
Funds
Each of these options has important tax implications to consider. It is important that a candidate deal with a qualified organization and tax professional to determine the best method. Taking a taxable distribution can quickly produce liquid funds, but also carries significant penalties and tax liability. Early withdrawals (before 59 ½) carry a 10% penalty. On top of that penalty, retirement account distributions are taxed as ordinary income. Because this distribution is added as ordinary income on top of any other income earned during the year, distributions often push candidates into a higher tax bracket. This means not only paying a higher percentage of tax on distributed funds, but also paying a higher percentage of tax on any other income earned during the year. While this method of funding should happen in 30 days or less, most candidates will only be able to effectively use 50-60% of the funds distributed because of taxes and penalties. Taking a loan from a retirement account is only possible with certain qualified plans. Offering loans is not a requirement. Rather, employers can elect whether to offer loans to their plan participants. Taking a loan from an IRA is not allowed. The challenge with franchise candidates is that loans are not rollover eligible. In order for candidates to take a loan from their retirement account, their employer must offer these loans. If the candidate purchases a franchise using retirement loan proceeds and then quits their job, they will likely be required to pay off the loan in full. Because IRAs do not allow for loans, these loans cannot be rolled into an IRA to avoid paying off the balance. The one exception is that some retirement plans will allow loans to roll to other qualified plans, such as a 401(k) or profit sharing plan. Thus, to avoid a loan payback, the candidate may need to set up a 401(k) or other qualified plan for their new franchise business. In addition, interest paid on a retirement account loan is not tax deductible. The time is takes to obtain a loan from a 401(k) or other qualified plan depends on the plan administrator. For most plans this should not take much more than 30 days. Investing retirement funds into a business is a great way for candidates to use up to 100% of their retirement funds in a franchise or business without taking a distribution, incurring penalties or paying interest. In theory, it is similar to purchasing stock in a publicly traded company such as Microsoft, but the company is privately held. Investing in a privately held company requires that the retirement plan and stock of the business are structured in specific ways. A company such as Guidant Financial Group can create the type of retirement accounts and stock necessary for candidates to invest into a franchise or small business. There are many benefits to such a plan. Candidates that have significant funds in their 401K are investing in a business they control and have a direct ability to impact. Second, their 401(k) will grow in value as the business grows and they should be able to defer income into their new company 401(k), if they so choose. Lastly, candidates often are buying the business without using debt. Reducing overhead by limiting or negating interest payments can allow candidates to reach profitability faster. The time to complete the process should be about 3 weeks.
Have a Business Plan Be Complete
and Thorough
Be Realistic Show How You
Will Pay the Loan Back
SBA Loans From
1996 to 2000, the SBA has guaranteed loans for more than 17,000 franchises
in nearly 1400 franchise systems. The amount guaranteed by SBA
exceeds $4 billion. When
applying for a Small Business Administration loan, first-time
entrepreneurs may not realize there are two sets of hurdles in front of
them: the requirements of the SBA to qualify for the loan, and the
requirements of the lenders who will actually make the loan. The SBA only guarantees loans submitted by a bank or financial institutions, it does not lend money. For loans of $100,000 or less, the SBA guarantees up to 80 percent of the loan value and up to 75 percent if the loan is over $100,000. The maximum loan guarantee is $1.5 million. The loan will be given to you by the bank that is a preferred lender of the SBA. The bank could be local, national or even virtual. A list of preferred lenders in Wisconsin is on the SBA website. The two types of loans applying to franchised businesses are the 504 program and 7(a) program; The 7(a) is by far the more popular because it can be used to finance franchise fees, leasehold improvements, equipment, inventory and working capital. The 504 program, on the other hand, is only good for real estate and hard equipment—geared more toward hotels and large food operations that necessitate buying real estate. According to the SBA, the criteria for acceptance are as follows: • The business must be able to repay the loan through historical and/or financial projections and supporting documentation. • The business must be able to carry more debt; if a new business, at least 25 to 30 percent of owner equity is required. • The business or owner must have some collateral, though 100 percent collateral coverage is not necessary. Lack of collateral is not the sole reason to decline a package, but it is not ignored. • Personal credit report must be good, or any credit problems justifiable and attempts made to rectify any issues. • The business and the owner cannot have delinquent taxes. • The business cannot obtain credit elsewhere; the borrower must show that credit is not available elsewhere and that the refinancing must result in a substantial benefit to the small business. • The business must show that the funds are not available from personal resources of any owner of the business; the SBA has a formula to determine the personal resources to be injected from personal resources (cash, savings, marketable stocks, cash surrender value of life insurance and home equity). • The business must meet the size and eligibility criteria of the SBA. Size criteria varies by industry and standards are based on the average number of employees for the proceeding 12 months or on the sales volume averaged over a three-year period. As for eligibility, some businesses cannot obtain SBA financing due to the nature of the business (lending institutions, non-profits and religious institutions, for example). Details are available on the SBA Web site (www.sba.gov).
Unsecured
Loans Signature Loan: A signature loan is a loan that is not backed by collateral (a home, investments or property). These loans are granted based on the borrower’s credit, income and ability to repay. Because there is no collateral given, interest rates on signature loans tend to run much higher than traditional loans. Many clients use unsecured loans as a way to make a down payment or fund a portion of a franchise purchase. Signature Line Of Credit: Similar to a signature loan, an unsecured line of credit does not require collateral. The qualification requirements are similar. However, a credit line allows you to borrow funds up to the line’s credit limit as needed. As a result, the borrower only pays interest on the outstanding balance. Credit lines can provide an excellent back-up for the operating capital needs of a new business. Underwriting guidelines for unsecured lines vary. For example, someone with a credit score of 680 and $100k in equity in his home may qualify for more than someone with a credit score of 760 and no home equity. Here are some common underwriting for obtaining an unsecured credit line:
Unsecured loans are ideal for people who do not have many other options, expect significant earning in the future or are simply looking for additional liquidity in the event that the business does not become profitable in the expected timeframe. VetFran
Program The $150,000 limit is based on the maximum loan amount for which the SBA will offer 85% loan guarantees (the highest percentage guarantee they offer). The veterans must apply with and get approval from the SBA. VetFran has seen a resurgence in popularity since 2002, when veterans from the War on Terror began returning home. As part of the VetFran Program, franchisor members of the IFA agree to help veterans get a franchise business by providing qualified veterans with exclusive financial incentives. Because veterans receive better deal than civilian candidates, it is often worthwhile for veterans to consider franchises offering this incentive. Angel
Financing There are many advantages to Angel Financing. It offers both the lender and the borrower more flexibility than other types of financing. Angel loans can be structured with little or no principle in the first year or with low note payments allowing the business to get up and running. If you are considering using friends, relatives for financing help, approach the project in an appropriately professional manner. Even Friends and Family like to see a well thought out proposal or plan, so be certain to present yourself in a business mindset when sitting across the kitchen table from the Angel. Show them your business plan and let them see your enthusiasm. Help them catch your fever. Make them a believer in you and your dream. There are websites that facilitate the loans between relatives.
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