Financing your Franchise Business
Posted on October 13, 2010 by Lindsay Hall
Due to the recent economic downturn, many people have begun taking their financial matters into their own hands. With long term job security becoming a thing of the past, many people are turning toward small business ownership to declare their financial independence. Buying into a franchise is one way that people are setting their plans into motion. The risks and rewards are great in any new business venture, but first thing, how are these people getting started? The first thing you need to get squared away is financing, but how? There are actually many options to secure financing for a new franchise and it will be up to you to decide which fits your situation.
Once you have researched franchises that you are interested in and made a decision on which you would like to invest in, you need to decide how you will pay your start-up costs. The Small Business Administration, a branch of the US government, can help you find grants and venture capital but they do not offer loans to cover all costs. You can present your business plan to your personal bank, but recent events have caused banks to tighten lending restrictions, especially with things like small businesses. In fact, it’s likely that to secure a business loan through your personal bank you would need nearly one-hundred percent collateralization. You may also talk with your franchisor about a start-up loan, or liquidate your own personal assets. In recent years, the most popular ways to acquire funding for buying a franchise is to either borrow from your existing 401(k) plan, or to take advantage of a government “loop-hole” called ROBS, or Rollovers as Business start-ups, which involves transferring your current 401(k) or IRA into your new business to be used as start-up cash.
Borrowing money from your 401(k) plan is a great way to finance your new business plans. You can borrow up to $50,000 or 50% of your total savings, whichever is less. If that doesn’t seem like enough capital, this idea can be combined with government grants, personal assets, or venture capital loans. Keep in mind that you will have to make regular re-payments to your plan, along with reasonable interest, until the loan is fully repaid. You would need to contact your 401(k) plan administrator to find out if you qualify for this route.
Hiring an experienced and knowledgeable franchise attorney is always a great idea, but if you plan to roll your current 401(k) or IRA saving plans into money to start your business it is absolutely essential. Basically, you can access all of your retirement money and invest it into your business, tax and penalty free. How does this work? Basically, your franchise attorney will set up a shell corporation in your name, establish a qualified retirement account in the name of your new corporation, move the money in your old 401(k) or IRA into the new one and you will invest the money from the retirement account in the stock of your franchise business, giving you the cash to start your business. Because you are transferring funds from one retirement account to another, you will not have to pay any taxes or penalties for cashing in your plan before the age of 59 ½. Using this method you are free to begin drawing a salary immediately, and you are also free to take any left over money in the new retirement account and invest in any variety of things, such as other businesses and real estate. You have much more control about how your future is being invested.
The ROBS method is a controversial topic in franchise business financing these days. I cannot stress enough how important it is to have an experienced franchise attorney with you every step of the way. Because the ROBS method creates a tax shelter, these transactions come under heavy scrutiny by the IRS. You will need professional assistance to ensure that your new corporation and retirement account follow all federal guidelines to the exact letter. Borrowing from your 401(k) is less legally complex, but you may be subject to penalties and large fees if you fall behind on your re-payments. Going through the Small Business Association, or through personal lenders may not net you enough cash for the full start-up. In any case, it’s vitally important to understand the risks and potential rewards involved with these options. Your future business success depends on how carefully you weigh your options.