Buying a Franchise – How to Determine What it’s Going to Cost You
by Caron_Beesley, Community Moderator
- Created: August 27, 2012, 7:07 am
Thinking of buying a franchise? Do you understand the franchise business model and have you determined it’s a good fit for you?
Perhaps you’ve also explored potential franchises and think you’ve found a match. But how are you going to finance your venture? What can you afford? How much financing should you seek? Should you even be doing this?
Should you Be Doing This?
Determining exactly how much money you should invest in your franchise purchase is an important question deserving of an entire chapter in Joel’s book –“Become a Franchise Owner”.
According to Joel, you may be asking yourself if you can afford to invest in a franchise, when you should be asking: “should I be doing this?” The answer to this question lies in your unique financial situation. To help you get a clear picture of your own finances, Joel recommends the following:
- Develop a Net-Worth Statement – Make a simple two-column list of your assets and liabilities. Add them up and subtract the latter from the former – this will give you a picture of your net worth.
- Talk to an Expert – Joel stresses the importance of consulting a financial advisor. A franchise is a major investment and an advisor can help you build a picture of what you truly can afford – not only in terms of the purchase price, but also how much your down-payment should be.
So How Much Money should you Personally Invest?
Your time with a financial advisor should give you the answer to this question. As a guideline, Joel suggests (but steers clear of an all-out recommendation) that franchise buyers should invest no more than 15 percent of their own money in a start-up franchise. Say, for example, your net worth is $400,000, of which $80,000 is liquid. The most you would want to invest in a franchise is 15 percent of your net worth, or $60,000.
Investing 15 percent isn’t a hard and fast rule. As Joel’s admits, this number is based on his own risk tolerance and vast experience. So it’s important to talk to a financial advisor to work out exactly what this percentage should be for you.
What Can you Afford to Buy and What do You need to Borrow?
Once you’ve determined what you can afford to contribute towards a franchise purchase, what kind of dollar range should you be looking at in terms of total franchise investment? In other words, what can you afford to buy and how much do you need to borrow?
Most lenders, Joel explains, want to see franchise buyers come up with 20-25 percent of the total investment in the franchise they’re trying to buy. Based on Joel’s math from above, $60,000 is 25 percent of $240,000. This means you shouldn’t look at franchises requiring a total investment greater than $240,000.
OK, so you’re investing $60,000 of your $80,000 in liquid cash in the franchise venture. Where do the remaining funds come from? This is where borrowing comes into play, either a small business loan or borrowing money from family or friends. Whichever route you choose, you still have $20,000 in your pocket you can save for a rainy day.
Stick to Your Budget
Now that you have a clear picture of what you can afford and your target investment range, be sure to stick to your budget. And, of course, have enough funds set aside to pay your own personal monthly bills. As Joel points out in his book, you’re not going to make money at first – so be prepared. Breaking even comes first, then profits, and only then can you pay yourself a salary (read more about in this blog: 5 Tips for Setting Your Salary as Business Owner).
Financing Options for Purchasing a Franchise
Many banks and credit unions offer financing for franchise purchases. In fact, SBA data (PDF) shows start-up franchises are more likely than other businesses to use a commercial bank loan as their source of funding.
When you approach a bank, be prepared to disclose all your financial information. While your credit rating is important, you’ll also need to provide a personal financial statement, copies of tax returns, and information about the source of your down payment funds.
You should also be aware that your choice of franchise will have an influence on a bank’s decision to fund you. Franchises with strong brand names, a track record of consistent profits and cash flow, plus an ability to perform well across a variety of diverse locations are going to stand you in good stead when you meet with your bank manager.
If your bank is hesitant about a particular franchise system’s performance, or your finances aren’t as strong as they could be, you might want to consider an SBA loan. SBA doesn’t lend to business owners directly; it provides a repayment guaranty to banks and lenders for money they lend to small businesses, making it less risky for the banks. Use this search tool to find the right SBA loan for you.
- SBA Guest Blogs – Read blogs from Joel Libava and other guest bloggers.
- SBA Buying a Franchise Guide
- Investigating a Franchise Opportunity: How a Little Detective Work and the Law can Help
- 5 Due Diligence Questions That Are Worth Asking Before You Buy That Franchise
- How to Prepare Your Loan Application
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