Preparing a loan-proposal package – financing a franchise – editorial
Andrew J. Sherman
Finding the money needed to buy a franchise is getting easier because more banks and nonbank lenders are viewing franchising as a safe investment. However, the process of obtaining loans remains time-intensive and somewhat complicated.
The first step toward securing a loan from any source is to prepare a loan-proposal package. The package contains several sections, including a business plan for the franchise.
Lenders typically want the package to show that the prospective franchisee has a strong management team and an experienced and supportive franchisor. It should also include personal financial statements showing net worth and sales projections that demonstrate the ability to service the debt.
You also should expect to show the lender how the accounts receivable program works; the proposed relationships with suppliers, distributors, and employees; and an understanding of the trends in the marketplace.
Most loan officers will apply the traditional test of the so-called “four C’s” of credit worthiness–character (reputation and honesty), capacity (business acumen and experience), capital (ability to meet debt-service payments), and collateral (access to assets that can be liquidated in the event of a default).
Many franchisors offer assistance to the prospective franchisee in preparing a business plan and a loan-proposal package. Often, the franchisor maintains a working relationship with one or more lenders and will provide access to them for the franchisee.
Although most prospective franchisees turn to traditional forms of financing from commercial banks–such as construction loans, term loans, and operating lines of credit–there exists a wide variety of alternative sources of debt financing. They include:
Direct financing and/or loan guarantees. About 30 percent of franchise companies offer some form of financial assistance–usually in the form of helping the franchisee find a bank or other lender. Some franchisors offer direct financing, loan guarantees, and a mixture of leasing programs on property and equipment needed to operate the business. (Note: If the franchisor does not demonstrate some knowledge and expertise in financial assistance, then look for another franchise.)
Trade credit. The use of credit with key suppliers is often a means of survival for small businesses. When a company has established a good credit rating with its suppliers but, as a result of rapid growth, tends to require resources faster than it is able to pay for them, trade credit becomes one way that growth can be sustained.
Equipment leasing. Most retail franchises need to use–though not necessarily own–equipment for fueling and maintaining growth. Leasing offers an alternative to outright ownership of the equipment. Monthly lease payments are made in lieu of debt-service payments.
Factoring. Under the traditional factoring arrangement, a company sells its accounts receivables to a third party in exchange for immediate cash. The third party, or “factor,” assumes the risk of collection in exchange for the ability to purchase the accounts receivables at a discount.
Equity financing. Prospective franchisees have successfully pursued a wide variety of equity financing strategies. For example, there is a form of private placement offering that allows the franchisee to solicit capital from family, friends, and business contacts in exchange for equity ownership in the entity that will operate the franchises.
Miscellaneous sources of nonbank debt financing. Debt securities, such as bonds, notes, and debentures, may be offered to venture capitalists, private investors, friends, family, employees, insurance companies, and related financial institutions by the franchisee.
To finance the purchase and growth of their business, many smaller companies turn to traditional sources of consumer credit, such as home-equity loans, credit cards, and commercial finance companies. In addition to the U.S. Small Business Administration’s loan programs, many state and local governments have direct loan programs for small firms.
Before pursuing any of these alternative methods of debt financing, however, consider hiring an accountant who is experienced in helping franchisees obtain financing.
Andrew J. Sherman is a Washington, D.C., attorney and is the author of Franchising & Licensing: Two Ways to Build Your Business, published by AMACOM Books.
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