You can overcome financing hurdles - Franchising: Special Guide

Nation's Business, Oct, 1993 by Meg Whittemore

The biggest obstacle faced by most potential franchisees in starting their businesses is, as always, finding startup capital. President Clinton has ordered regulatory changes designed to reduce certain bank-loan paperwork and encourage more loans for small businesses, but it can still be difficult for business newcomers to borrow money to buy a franchise.

One of the basic problems for banks considering a franchise loan is that "there is never enough collateral," says Dennis Jones, president and CEO of Hinsdale Bank & Trust Co., in Hinsdale, Ill. "People go into franchising because of the relatively low cost to get involved, and they usually use up a large portion of their net worth--or borrowing power in order to buy the franchise," he says.

"Franchise loans are unsecured cash-flow loans," says Thomas Mulry, vice president of National Westminster Bank USA, in New York City. Typically, he says, the money involved isn't enough to attract a bank unless the loan is for a restaurant or hotel franchise in the range of $500,000 to $1.5 million.

The market for money is expected to remain tight for the foreseeable future, at least among traditional banks, but some smaller banks are eyeing franchise financing as a growth market. "I think one of the last bastions of users of commercial banks' money is going to be the small-business owner, many of whom are franchisees," Jones says. "So there is hope."

(For suggestions on approaching your banker, see "Visiting A Loan Officer? Be Prepared," on Page 60.)

If traditional bank loans are unavailable to you, there are alternatives, including personal savings, loans from family and friends, and money obtained through U.S. Small Business Administration (SBA) programs. In addition, franchisors often prove instrumental in helping potential franchisees obtain start-up capital from banks and other sources.

Sometimes, a novel approach becomes a critical factor in a franchisee's success. Following are examples of how franchisees and franchisors are creatively meeting the challenges of financing:

Selling The Farm

Curt and Candy Holstein broke the rules of investing in a business when, in 1987, they bought two Riverside, Calif. franchises of Merry Maids, a home-cleaning company based in Omaha, Neb. The first franchise cost $50,000. "We financed the purchase of the first franchise by selling our house and 80-acre family farm in Nebraska," Curt says. '"We sold our heritage, and that was tough." The three-generation farm dated back to the turn of the century.

Candy, a schoolteacher, stayed in Nebraska to finish the school year while Curt moved to Riverside to start the business. When Candy joined him in California later that year, they considered an adjoining territory for a second franchise. "I felt that we needed the second area to accomplish the growth that we wanted, but I didn't have enough cash in the bank, and the franchisor didn't provide financing then," Curt says.

So the Holsteins bought the second franchise territory for $20,000 and put it on their credit card. "It is kind of embarrassing to have done it that way," Curt says. "An astute financial person would not have done that, but it was quick and easy cash for me."

The second territory allowed the Holsteins to increase annual sales to $10,000 the following year from $2,000 the first year, but Curt doesn't encourage people to follow his high-risk form of financing. "Let me put it to you this way," he says. "It was really dumb, and everybody advised against it."

At the time, he says, it was the only way to get the cash he needed for expansion, and his unorthodox strategy paid off. In 1992, sales for the two franchises totaled just under $600,000.

The Holsteins have no regrets, but they would not recommend selling the family homestead and using a credit card to finance a start-up. Instead, Curt and Candy suggest a conservative and thorough approach. The couple did do extensive research before launching their franchises, drawing up a formal business plan. 'You should understand your numbers before going in," Curt says. That means knowing how long it will take to break even and start making money.

Curt suggests that potential franchisees first approach a bank for financing, then try family, friends, and the SBA.

A final thought: "If you haven't put together some kind of pro forma game plan," Curt says, "then don't get into franchising, period."

Limiting Debt

A common-sense approach helps Dianna Nordyke's franchisees keep their initial investment and debt manageable while they support themselves and their families during the start-up phase. Nordyke is founder of Craters & Freighters, a packaging and shipping company based in Aurora, Calif. It specializes in large, odd-sized objects. "I don't like to see my franchisees invest more money than they have to," says Nordyke, who started the company in 1990.

A Craters & Freighters franchise, which is typically located in rented warehouse space, costs $30,000 to open if all of the equipment is bought new. Nordyke tries to help her franchisees pay less by requiring them to do a household inventory. "A lot of the equipment they need in the warehouse, such as power saws, drills, tool boxes, and saw horses, is stuff they already have in their garages," she says. "There is no sense in going out and buying brand-new things when they have perfectly usable things at home."