Options for Retirees to Finance the Purchase of a Franchise

Author: Vasilis Georgiou, CBI, M&AMI, CBB, MBA, CIRM

President, CrossRoads Business Brokers, Inc./ Franchise Consultant with FranChoice

There is an interesting trend in the franchising world where more and more retirees are showing increasing activity in buying franchises. The economic and work environment realities after the economic crisis, have forced many folks of the baby boomer generation to take matters into their own hands, so to speak. They are looking for ways to be masters of their own destiny through business ownership, but they want to do it in a measured, deliberate way that minimizes the risk as much as possible.

Starting a business is inherently risky, and there isn’t such a thing as complete certainty of success. For a retiree or a baby boomer, that gives even more reasons for a pause for thought because time is not a luxury they can afford. That is why many are turning to the franchising model of business ownership where not only they can have access to well-publicized and regulated information about the performance of the system as a whole, but also have the opportunity to validate first-hand through interactions with existing franchisees.

Once a decision is made to buy a franchise that best fits individual aspirations, skills, and talents the question comes up as to the best financing approach that leverages existing assets, and does not deplete all capital, just in case it will be needed to sustain a longer launch effort. Many options exist, and the purpose of this article is to highlight them:

1. Retirement Funds and/or Savings
One inherent advantage retirees typically have is that after many years in various careers in industry, they have been able to accumulate some amount of retirement funds. There is a way for retirees to use these retirement funds to finance a franchise (or any business), tax free. Whereas in traditional borrowing you have to go through a rigorous and lengthy application process, leveraging retirement funds is typically faster and more straightforward. There are some benefits in this approach compared to other available options (Always consult with an accountant and a lawyer to ensure that your financial transaction is in complete compliance with law provisions):

  • Limits debt and enhances cash flow in the critical start-up phase of the business. Thus, resulting in a better chance your business will break even faster, and generate profits sooner
  • Low fees
  • As your business gains momentum and grows, your IRA will grow as well. Best part about it, it will grow tax free
  • More flexibility in case traditional borrowing needs to be in the mix for a larger investment. Funds may be used as the personal equity injection for SBA or conventional loans
  • Utilizing these funds to capitalize your business allows you to invest in yourself
  • Allows for tax-deferred retirement savings options in the future
  • Begin paying yourself a salary during the start-up phase

This is how it works: One specific law, The Employee Retirement Income Security Act(ERISA), allows a variety of retirement savings accounts to be utilized as a vehicle for investing in various options, including buying a franchise. The chosen corporate vehicle is a “C corporation which you have to form, which then can be eligible to create its own 401k program. You can roll over (tax free) existing retirement funds into your new corporation’s 401(k) program. The new corporation’s 401(k) program can invest in the stock of the new “C” corporation which can then use the proceeds to buy the franchise. You can only use the funds in your 401(k) account after you leave the company where it originated.

2. *Small Business Administration (SBA)
There are several types of loans available through the SBA. The most commonly used for the purchase of a franchise is as follows:

  • General Small Business Loans: 7(a)
  • Real Estate and Equipment Loans: CDC/504

As described on the SBA website (www.SBA.gov), the 7(a) Loan Program, which is the SBA’s most common loan program, provides loans to businesses with requirements of eligibility based on specific aspects of the business and its principals. In other words, the key factors of eligibility are based on what the business does to receive its income, the qualifications and backgrounds of its owners, as well as where the business operates.

On the other hand, a 504 loan could be suitable for franchises that involve retail locations, or investment in equipment and machinery. Specifically, a 504 program can be used for:

  • The purchase of land, including existing buildings
  • The purchase of improvements, including grading, street improvements, utilities, parking lots and landscaping
  • The construction of new facilities or modernizing, renovating or converting existing facilities
  • The purchase of long-term machinery and equipment

A 504 loan cannot be used for:

  • Working capital or inventory
  • Consolidating, repaying or refinancing debt
  • Speculation or investment in rental real estate

The SBA generally does not specify what businesses are eligible. Rather, the agency outlines what businesses are not eligible. However, there are some universally applicable requirements. To be eligible for assistance, businesses must:

  • Operate for profit
  • Be small, as defined by the SBA
  • Be engaged in, or propose to do business in, the United States or its possessions
  • Have reasonable invested equity
  • Use alternative financial resources, including personal assets, before seeking financial assistance
  • Be able to demonstrate a need for the loan proceeds
  • Use the funds for a sound business purpose
  • Not be delinquent on any existing debt obligations to the U.S. government

*Source: www.SBA.gov

3. Securities-Backed Financing
Another inherent advantage retirees typically have in funding a new franchise is that after many years in active investing, they have been able to accumulate some amount of stocks and bonds. They are then able to utilize qualified securities (i.e. stocks, bonds, mutual funds, U.S. Treasuries) to obtain a low interest line of credit.

There are advantages to using securities instead of traditional borrowing:

  • Pay interest only on the amount used
  • Loan-to-Value of Approved Assets from 70%-90%
  • Get working capital to start or expand your business
  • Supplement other capitalization plans
  • Not credit or income based

4. Home Equity
The housing market has recovered well recently from the worst downturn in recent years. A home equity line of credit (HELOC) can be used to fund a new business venture. You should carefully check interest rates and repayment terms.

5. Family and Friends
That is always a tricky approach. There is natural hesitation to mix family and friends with business. What if the whole franchise thing doesn’t go well? Where is that going to do to the relationship? Those concerns are well justified. However, transparency and well written Agreements that spell out the financial and operational responsibilities of each investor, together with a clear disclaimer of the risks associated with new ventures, can mitigate some of the downside to leveraging this kind of resource.

6. Franchisor
Franchisors want to enable new franchisees to start a location. Especially if the franchisee candidate is qualified and shows promise of success. After all, franchisors have a long term royalty incentive in placing good franchisees in the system even if they take less cash up front, and have to finance some of the cost. They look at it as a win-win. The royalty annuity can be substantially more in the long term. That is why some franchisors offer programs that partially finance the upfront fees, especially if equipment assets are involved.

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