Biz Funding Hub

 

The Various Ways To Fund Your Biz Purchase

The Various Ways To Fund Your Biz Purchase

Purchasing a franchise or existing business can be a smart choice for an aspiring entrepreneur. Becoming a franchise owner gives you the flexibility of owning your own business with the added security of being part of an established brand. Buying an existing business enables you to hit the ground running and leverage existing resources to accelerate your growth, which often means you can get farther in a far quicker manner. That being stated, as with owning any new business, start-up costs can be high and you may require infusions of capital if you encounter hard times.

Franchisees must also pay a franchise fee when opening a new franchise, as well as ongoing royalty fees. Buying an existing small business may very well mean that you are also purchasing the company's existing debt. The bottom line is that you absolutely need a good business plan, healthy cash flow, and solid financing in order to succeed. Assuming that you simply do not have upwards of $50,000-$100,000 or more set aside, how can you get the capital you need to open a franchise or purchase an existing business?

The good news is that there are numerous financing programs that may be available to you. However, you may very well find that it is fairly challenging to navigate the various options, so we have simplified the process of financing your franchise or existing small business purchases by breaking down the most popular financing options.

Franchisor Financing

If you need funding to purchase a franchise, the prospective Franchisor may very well be your best option. Many corporations with franchise business models offer tailored financing solutions exclusively designed for their franchisees, either through partnerships with specific lenders or by providing capital directly from the corporation. This is one of the most common ways to finance a franchise and offers many benefits. One benefit of using franchisor financing is that it becomes a one-stop-shop for everything you need.

Many of these programs offer financing not only for the franchise fees but also to purchase equipment and other resources you need to start up the business. If you are working with a Franchisor who offers their own financing program, you may not need to look much further for funding. After all, who knows the business better than the Franchisor? They know the risks that you are taking on and the ins and outs of the business better than any other lender ever could. Each Franchisor financing agreement will differ, but some offer to take on as much as 75 percent of the debt burden from the new franchise owner.

Agreements might involve deferred payments while the business is starting up, or they may structure repayment on a sliding scale. Have your business broker, independent business attorney, or accountant review the terms of both your franchise agreement and the financing agreement to help you understand the full terms before you sign.

Seller Financing

Seller financing is a loan the seller of an existing business gives to the new buyer to cover all, or a portion, of the total purchase price. Seller financing for business carries strong benefits for buyers of existing businesses. In essence, this type of loan may provide buyers access to more capital to purchase the business. Seller financing occurs during the sale of a business when the seller decides to finance a portion of the purchase price. It can be the primary financing source, but more typically is used as a portion of the capital stack to complete the purchase.

Seller financing is also referred to as seller carry back, seller carry, or owner financing. Sellers who offer financing act a lot like a bank would in the business sale transaction. They can check the credit report of the buyer, ask for a personal financial statement, resume, and other pertinent information, all before making a financing decision. They may also request collateral and a personal guarantee to secure the loan. To increase the chances of getting seller financing, buyers should make sure they have a strong credit score. A good credit score is 680 or above.

Above 725 is considered great. Having a score lower than that will hurt your chances, but not totally eliminate them from being approved by the seller. Seller financing is typically cheaper than getting a loan from a lender, meaning the terms can be far more favorable for the buyer. In addition, a lot of buyers will not commit to purchasing an existing business that does not offer seller financing due to the fact that the seller has no skin in the game.

In essence, the business opportunity does not look as attractive if the previous owner does not want to be involved at some level moving forward. Always have your business broker, independent business attorney. or accountant review the terms of the seller financing agreement.

Small Business Administration (SBA) Loans

Of all the loan products on the market, one of the most desirable options for aspiring franchisees tends to be the SBA loan. SBA loans are loans that are partially backed by the United States Small Business Administration, and funded by their intermediary lending partners. Effectively, these loans follow a very similar model to traditional term loans from a bank or alternative lender. However, because the SBA reduces the risk to lenders by guaranteeing a portion of the loan amount, lenders have more incentive to offer loans with lower interest rates and longer repayment terms than they otherwise would.

The SBA loan is certainly a desirable option for financing a franchise or existing business purchase, so if you have the financial well-being and credit score to be eligible, you should absolutely apply. That being stated, keep in mind that qualification standards can be stringent, and the application process is a long one. It is certainly worth carefully considering your chances of being approved for an SBA loan prior to spending a significant amount of time pursuing a financing option that may be unavailable to you. There are multiple types of SBA loans that you can apply for as listed below.

The SBA 7(a) Loan

SBA 7(a) loans are small business loans of up to $5 million that is provided through the Small Business Administration. The SBA 7(a) loan program is the most popular of all the SBA loan guaranty programs because the capital it lends can be put toward a wide range of business purposes, such as working capital or commercial real estate. Due to the partial guarantee that the SBA provides through the program, SBA 7(a) loans come with ideal terms. For example, the loan term lengths can go up to 25 years, and the interest rates can range from Prime Plus 2.25% to Prime Plus 4.25% depending on loan size. The SBA will review your loan application and give you an initial approval decision within 5 to 10 business days. The biggest disadvantage of an SBA 7(a) loan is that it's difficult to qualify. SBA 7(a) loan terms are very attractive, so even with the SBA guarantee, these loans are highly competitive for small to mid-sized businesses to secure. Specific requirements vary from lender to lender, but there are certain basic criteria that apply across the board.

The SBA Express

The SBA Express loan, available for loans up to $350,000, offers a quick turnaround to applicants in a time-sensitive bind, instead of the usual 5 to 10 business days. The SBA will review your application and give you an initial approval decision within 36 hours for Express loans. Since the approval decision is faster, the SBA only guarantees up to 50% of that loan. Just like the previous two options, the interest rate for an SBA Express loan can be negotiated by the lender and borrower, but it can never exceed the SBA-designated maximum.

The SBA 504 Loan

An SBA 504 loan can be used to purchase a franchise, existing business, fixed assets, and even to upgrade existing assets. In essence, the bank or lender extends 50% of the total loan amount, an SBA approved certified development company (CDC) extends 40% of the loan amount, and the borrower is responsible for a 10% down payment. The bank and CDC work closely together in issuing your 504 loan, however, it is important to remember that the SBA oversees and regulates only the CDC component of the loan. In essence, banks are free to set their own eligibility requirements and terms for the bank portion of the loan.

The maximum loan amount on the CDC portion of the loan is $5 million, extending up to $5.5 million for green energy companies and manufacturing businesses. The bank portion of the loan can be double, or even triple, the size of the CDC portion, bringing total possible funding to $20 million or even higher. The 10% down payment is typically half of what banks require for conventional loans. The down payment can come out of personal savings, other personal assets, and even retirement money in some circumstances.

You can also use a personal loan as the down payment if you have an income stream independent of the business to pay back the personal loan. In general, other business debt can't be used for the down payment, unless payments on the other loan are not due until after the term of the SBA 504 loan.

If you are planning to purchase a franchise, the SBA has a directory of approved franchises that are eligible for financing. You can access them directly by clicking on the following link.

https://www.sba.gov/sba-franchise-directory

Commercial Bank Loans

Another common way of financing a franchise or existing small business purchase is through a traditional term loan from a bank. A term loan is what most people think of when they think of any form of loan financing, especially if you've ever taken out a student loan or home mortgage. Under this model, a bank or alternative lender offers you a lump sum of cash upfront, which you then repay, plus interest, in monthly installments over a set period of time. When you apply for a commercial bank loan to purchase a franchise, your lender will want to review your business plan and personal credit history.

The lender will use these documents to assess your creditworthiness. Essentially, through this process, the bank is trying to determine whether or not you can reasonably afford to repay the loan you're requesting, and thereby how likely they are to get their money back. Overall, you can assume that the stronger your financial history and the higher your credit score, the better the terms and interest rate will be for your term loan to finance a franchise or existing small business.

Alternative Lenders

If you need money to fund your franchise quickly or want to secure additional capital to supplement your commercial or SBA loan, you may want to consider applying for franchise/business purchase lending through an alternative lender. Typically speaking, alternative lenders have less stringent requirements and shorter turnarounds than traditional financing options. They offer a variety of loan options like equipment financing, business lines of credit and even term loans.

Here is the bad news. This easy access and convenience may cost you. Alternative loan products tend to be more expensive, offer shorter repayment terms and lower loan amounts than their more-traditional counterparts. However, it may be worth it if you need to supplement your existing financing, simply cannot qualify for a bank or SBA loan, or need cash quickly to jump on a life-changing opportunity.

401(k) Loans

When you face a financial need, such as purchasing a franchise or existing business, it can be tempting to tap into your 401(k) in order to access the money. That being stated, you need to be aware of how a 401(k) loan works. Technically speaking, a 401(k) loan is not actually a loan since the only lender involved in the transaction, is you. In essence, you are accessing your retirement funds early and then replacing them with interest to replenish your retirement savings.

Both the IRS and your employer set the rules for borrowing from your 401(k), and although companies are not required to offer 401(k) loans, the vast majority does allow them. IRS rules set a maximum loan amount of 50 percent of your vested balance or $50,000 whichever is less. If you have $100,000 or more in your 401(k) account, the max you can borrow is $50,000. If you have under $100,000, the max you can borrow is half of the balance.

For example, if you have a 401(k) balance of $90,000, the maximum you can borrow is $45,000. The IRS requires 401(k) loans to be repaid within five years, and the payment plan is established at the time you borrow the money. The good news is that there are zero credit checks, since it is your money, and the interest rate is typically very low. You are actually paying the interest to yourself because it goes directly back into your 401(k) account.  In addition, there are no prepayment penalties on these loans, so you can pay it off early without being penalized.

401(k) Rollovers As Business Startups (ROBS)

Rollovers as Business Startups, or ROBS for short, allow you to invest retirement funds from a 401(k) in order to purchase a franchise or existing business without paying any taxes or early withdrawal penalties. A ROBS is not a 401(k) loan or other types of business loan, which means there are no interest payments to make or debt to repay. ROBS can be an effective manner in which to fund your new opportunity when done correctly. Here is how it works:

When you utilize a ROBS your retirement account actually owns shares of your new business. A 401(k) rollover involves incorporating a new business and opening a new 401(k) under it. Setting up a ROBS requires you to create a C corporation or C-Corp for short, and then establish a retirement plan, like a 401(k) for that new C-Corp. After the C-Corp is set up, you roll over funds from your existing personal 401(k) account into the new company's retirement plan. Utilizing the funds that you have rolled over, the new 401(k) plan purchases stock in the C-Corp, at which point the ROBS 401(k) rollover is completed and your franchise or existing business purchase is capitalized.

Crowdfunding

If you have found the perfect franchise or existing business to purchase, but none of the traditional financing sources as listed above has panned out, all is not lost. That being stated, obtaining financing may require some creativity. One of the newer and more creative ways of financing a franchise or existing business is through crowdfunding. You may choose to set up and promote your own personal crowdfunding page or look towards specific organizations that crowdfund for businesses and franchises.

There are also websites that crowdfund for specific industries and business types, which they then lend those funds to people in need of financing. Crowdfunding is an excellent option if you happen to have a blemish or two in your financial history and either does not qualify for loan products, or are not happy with the interest rates for the programs that you do qualify for.

The Friends And Family Loan

Perhaps the most common way to finance the purchase of a franchise or existing business is by borrowing the money from your family and friends. Whether you choose to borrow money outright, ask for a gift, or bring a friend or family member on as your business partner, these types of loans generally come at a very good price. That being stated, some come at the cost of lost friendships and family disagreements. If you do choose to take a loan from a friend or family member, be sure to write up a contract that includes repayment terms and expectations. If everyone understands the agreement before signing, breakups and disagreements will be less likely in the future.

 

State And Territory Business Resources

There are various financing programs for purchasing a franchise or existing small business depending on your state or territory.

For example, "Advantage Illinois" provides entrepreneurs in the state of Illinois with access to capital needed to purchase a franchise or existing small business with favorable terms. In essence, the intent of the program is to create jobs that will foster the local economy.

 

You can find out more information about what your state or territory has to offer by clicking on the following link.  https://www.usa.gov/state-business