At one time, a good credit score and the backing of a big franchise name was enough to secure funding for a new franchise venture. But these days, credit is so tight that many dreams of franchise ownership have had to be put on hold. Nevertheless, some entrepreneurs have persevered and found a way. Here’s a look at three different strategies franchisees have used to defy the sour economy and fund their franchises.
Friends and Family: Mike Hup opened the doors to his Elevation Burger franchise in Wynnewood, Pennsylvania, in July 2009. However, before he could even think about selling burgers, Hup had to devise a way to come up with the $600,000 necessary for the buildout, the purchase of the equipment, and the franchise fees. His brother-in-law came to the rescue, not only putting his own money into the venture but also locating two additional investors who were interested in being involved. Today, they each own equal shares of the franchise but leave Hup to serve as sole operator. “For years, my brother-in-law and I had talked about doing a business together,” says Hup, “so it was an immediate fit.”
Borrowing from friends and family was the most straightforward solution for Hup; yet he advises thinking very carefully before entering into such a partnership. “[My investors] are partners in the business,” says Hup who hired lawyers to go over all the loan documents. “It is more than just a loan. They get the upside and all the risks. Make sure everything is spelled out clearly and done properly. Don’t cut corners.”
Rounding up money from friends and family has become increasingly common in light of the tough economy. However, don’t let informal relationships lead to informal agreements. “Without proper documentation or a clear legal structure, an entrepreneur will have a lot of problems down the line when trying to get traditional bank and/or SBA financing or even when filing tax returns,” cautions Ami Kassar, co-founder and partner at MultiFunding, a business loan advisory firm.
In cases where friends and family members are involved as investors, Daniel G. Shifrin, founder and CEO of FranEquity, a propriety financing platform that connects investors and entrepreneurs, advises paying especially close attention to the type of investment vehicles and structures used. According to Shifrin, the most prevalent and fair investment vehicle is a “Bridge Loan”; however, regardless of the type of structure used, Shifrin recommends that the agreement specifies the following:
- The type of entity that will be created
- The roles of each individual
- Employment agreements
- Exit and default clauses
- Arbitration rules in the event of a breach or argument between shareholders
Private Equity Firm: When John Ikirt decided to leave his career to purchase a ComForcare franchise in Dayton, Ohio, he had everything in order – except his finances. Able to fund only about half of his franchise from his personal savings, Ikirt was in need of the remaining amount.
That’s when a key introduction came into play in a very big way. In mid-2008, a friend had introduced Ikirt to Harry Loyle, the owner of venture capital firm Cybeck Capital Partners. In 2009, seeking a solid investor for his franchise, he turned to Loyle for assistance. Not only did he get the financial backing he needed, but Loyle also offered some invaluable insight. “Harry was instrumental in assisting me with doing a financial pro forma analysis of the purchase of the business as well as an analysis of the market opportunity,” says Ikirt.
So how do you go about getting noticed by a venture capitalist? While Ikirt happened to be introduced via a friend to Harry Loyle and Cybeck Partners, he says, you can find private equity investors online, by calling industry associations, and by calling your local bank and asking the business loan department for names or referrals.”
When scouting out private equity firms as potential investors, Ikirt recommends paying close attention to whether they specialize in specific business sectors, whether they will be compatible with your needs and personality, and extent to which they’ll be involved in your business following the purchase.
Cybeck Capital Partners provided the missing piece in Ikirt’s case; however, don’t put all of your efforts into the private equity basket. While private equity firms are starting to become more active in funding franchisors, the money is only slightly trickling down to franchisees. “Generally private equity firms only look at large deals with significant equity returns,” says Shifrin. “Angel investors/family members or other potential franchisees are more likely to invest in a potential franchisee for the purpose of earning consistent cash returns on their investment.”
Untraditional Sources and Small Banks: Since opening his Beef ‘O’ Brady’s franchise in Newport, Kentucky, in July 2009, customers have thanked him again and again for taking the risk to open his restaurant in such a struggling economy. Yet only Drennen knows how close he came to never launching the franchise at all.
Opening a Beef ‘O’ Brady’s called for major funding so, before all else, Drennen did his due diligence and visited several banks for pre-approval of an SBA loan. All gave their approval, and, in early 2008, he purchased the franchise rights. By May, he had secured a CIT-approved loan for $500,000. However, in September, everything came to a screeching halt when CIT called to inform him that they were freezing all of their SBA loans – everything except for the $5,000-a-month rent payments on the space he had leased.
Desperately, Drennen revisited all the banks that had previously given their approval, only to be told that they were no longer funding SBA or new startup loans. It wasn’t until April 2009, when he visited the Small Business Development Center at his local university, that he finally found his lifeboat. He was directed to the Northern Kentucky Area Development Center, which had developed a revolving loan fund, and got approved for a $100,000 loan. He was subsequently able to secure a small loan from a local bank.
Are you going through the same struggle? “If you are turned down, learn and move forward,” advises Drennen. “Take the bank’s criticism and make it work for you when you speak to the next bank. Be prepared and organized; answer every question the bank throws your way. Prepare for worst-case scenario. Think outside the box and look for untraditional sources. Speak with local business leaders for advice; make contacts and spread the word. Visit your local Small Business Development Center. Have an open mind.”
All three entrepreneurs managed to find a way to open franchises even when the economy had come to a standstill. Thanks to some creative thinking and a whole lot of determination, they made their dreams of franchise ownership come true. Says Drennen, “I dream of looking back 30 years from now, after developing many other ventures, and telling a story of how resiliency through a ‘depression’ made me the man I am today.”
Sara Wilson is a freelance writer who specializes in issues related to small businesses. Contact her at email@example.com