For individuals seeking the rewards of entrepreneurship but looking for a safer bet when launching into the business space, purchasing a franchise is a great route to go. Some even refer to franchises as a paint-by-number business. You get the proven game plan from the franchisor and then implement their rock-solid system. This route is especially popular for individuals looking for a second career, often times exiting the corporate world.
But no matter where you are in your professional life, once you’ve decided to pull the trigger on the franchising route, you’ll need to address how you’ll pay for it. Here are several options to consider.
The first route is coming to the table with cash. This could come from liquidating investments or pulling out equity from your home. While simple and straightforward, this option is less common due to the startup costs and the initial fees. Someone coming to the table with cash is likely purchasing a digitally based business with lower startup costs or an investor buying units with the intent to bring in a manager.
The second option is to seek a Small Business Association (SBA) loan. These loans are designed for small businesses and startups. A lender is able to take a little more risk and loan to a smaller business with less of a track record due to the loans being partially guaranteed by the government.
Borrowing Money from a 401k Tax Free
If you have a 401k from your previous company, you can borrow from it tax-free to fund your business venture. Many individuals who chart out their second act are too young to retire, yet have invested a substantial amount into their 401k. Some chose to put this money to use by investing it as seed money to open their franchise unit. Once the business is up, running, and profitable, they pay back the loan.
If you decide that a 401k loan is the right route for you, don’t go through the process alone. Be sure to work with a company or provider who will help you navigate the legal and tax nuances. There are specific regulations and guidelines that you must follow, or else you could land yourself in serious trouble with the IRS. For example, you must setup a C Corp for the business prior to starting the process.
Another option is bringing in other investors to go in on the business together. The investor size will vary depending on the amount of the investment and how many possible units or territories you are considering. To protect all investors, you would need to form an entity such as a corporation or limited liability company and assign ownership interest. For example, if you have four investors all investing $50,000, each individual would have an equal 25% interest in the company.
To successfully pursue this route, you should also discuss and create concurrent with the formation of an entity, a Buy-Sell Agreement to address the proper terms for individuals who pass away, become disabled, choose to exit, or go through a divorce. It’s also important to determine management and how much involvement each owner will have in the day-to-day operations of the franchise.
In many cases, franchisees leverage multiple payment routes to finance their franchise purchase. Depending on your financial situation, you might consider exploring combining some of the aforementioned options to secure your new business venture. For example, you could combine cash investments with a partial 401k loan and an SBA loan. Additionally, you could use that combination to fund your percentage of ownership for a group ownership option.
Creating a Strong Legal Platform
Regardless of which route you decide to fund your investment, at some point during the purchasing process you will need to sit down with a franchise lawyer to review the FDD. As both an experienced franchise lawyer and a part owner of a franchise, I help individuals like you start their new endeavors on a strong legal platform.
If you’ve narrowed down your search to a select few franchises to purchase into, contact me today. Together we can ensure that you’re investing into a solid business model.