It's not uncommon for entrepreneurs and business operators today to tap into their 401k or other retirement accounts to seed growth and expansion. This holds true in franchising as well. If you're a multi-unit franchisee considering how you might use your 401(k) to expand your operation you probably have questions.
We asked Rocco Fiorentino, CEO of Benetrends, to explain how the process works, the pros and cons, and legal implications. Benetrends has more than 25 years of franchise industry experience helping more than 10,000 entrepreneurs to fund their business over the last 30 years. Fiorentino shares the most common questions franchisees have asked about financing growth.
Who should I approach to help fund my business?
Franchisees often make the mistake of restricting their application to their local banks. Consider aligning with a company that has experience with a variety of funding options and can create a customized package to meet your needs and enable you to reach your goals. Many local banks just do not have this expertise.
What are my options?
You can choose from 401(k)/IRA retirement funding, Small Business Administration (SBA) loans, securities-backed loans, equipment leasing and merchant cash advance -- or a combination of several of these options. It's critical to have an initial consultation with a specialist, so your goals and current financial situation can be assessed. Only then will any company be able to make the best recommendation. At Benetrends, we work with clients to determine the ideal combination of funding, from just one source to a combination of up to 15 sources.
How much capital do I really need?
It's important to remember your initial capital will not only cover your startup costs, but also provide extra cash to run your business until you hit the break-even point. Don't underestimate how much you'll really need at the beginning. Whichever company you choose to fund your business can help you determine the appropriate number.
What is the most popular source of funding for franchises in today's economic environment?
An SBA loan is the most common type of loan for purchasing a franchise. Banks are more willing to assume the risk of lending money because an SBA loan provides up to an 85-percent guarantee.
What are the most important things to consider when choosing a strategy to fund franchise growth?
Liquidity. Simply stated, the need to demonstrate sufficient post-closing liquidity is the single most important factor to consider. The ability to support the new business through the startup phase with funds on hand, and sufficient liquidity to consider multiple locations as a growth strategy are significant considerations for both the franchisee and the lender. Stated another way -- is there adequate working capital available in/to the project to protect the new business and provide for growth?
Is it getting any easier to get an SBA loan?
Yes, the SBA has several new programs and it is embracing franchising. Traditional banks favor businesses with brand names and long track records of consistent cash flow. Even with healthy businesses and solid collateral, most bank loans to new franchisees occur if the borrower has an established relationship with the bank or has significant previous experience. While that represents some prospective franchisees, a large majority of them are turning to loans backed by the U.S. Small Business Administration.
The standard SBA loan for franchisees is known as the 7(a), which is issued by a bank or other lender and partly guaranteed against default by the government, which makes them less risky to the lender.
While it's getting easier to get an SBA loan, borrowers still need to be credit worthy, typically must contribute some equity, and are expected to repay the SBA loan out of the new business' cash flow.
Can I really use my retirement funds without taxes or penalty?
Yes. IRS regulations permit the rollover of funds from qualified plans without taxes or penalties. There are a few plans that cannot be used, including Roth IRAs, distribution of death benefits from an IRA other than to the spouse, and 457 plans for non-governmental agencies. Using your 401(k)/IRA is a highly specialized field and compliance is important, so work with a company that has expertise in this type of funding.
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