How to maximize your funding strategy in multi-unit development.

We find more and more entrepreneurs are looking to develop a funding strategy that will allow them to develop multiple units.  The most common scenario is the desire for a “three-pack” over a two to three year window.  Funding multi-unit development may have been difficult in the past, but since the credit crisis in 2008, financing a multi-unit strategy is even more challenging than ever. While every entrepreneur’s needs and situation are different, one thing is universal; how you fund the first unit effects your ability to fund the future units.  In other words, if you arrange financing for the first unit without considering how that is going to affect your ability to get additional financing, you may find yourself without any options to fund your second and third units. With that in mind, let’s look at a few different scenarios and some possible strategies to successfully obtain the funding needed to become a multi-unit franchisee.

Scenarios and Strategies

Any funding strategy is going to need capital, whether to fully fund the project without financing, or as a capital injection for a loan (typically an SBA loan). Let’s start with where you’re going to get the money you need.  Asking for a loan from your friends and family is a popular strategy, but if you believe what William Shakespeare wrote in his play Hamlet, ”Neither a borrower nor a lender be; for loan oft loses both itself and friend” simply stating ; borrowing from friends and family may not always be your best option.  Home Equity loans have been a traditional source of funds for entrepreneurs, however since the real-estate crash; home equity loans are not as popular as they once were, and are certainly harder to get.  In many cases, the equity has vanished as home values have decreased. That leaves us with personal savings or possibly utilizing your 401(k) funds in conjunction with SBA funding.

If you have sufficient funds in the bank to either fund your project entirely, or enough for the capital injection for a loan, you’re in great shape to move forward.  However, many entrepreneurs today have the majority of their savings locked away in retirement plans such as IRA’s and 401(k) s, which carry severe penalties and tax consequences for early withdrawal.  For example, if you have $200k in an IRA or 401(k) and take an early withdrawal, you may be required to pay a 10% penalty and as much as 30% in ordinary income taxes, leaving you with only $120k of your original $200k. The last thing you want to do when starting your business is to lose 40% of your working capital paying taxes and penalties on your savings. Fortunately, by utilizing a popular strategy known as a 401(k) ROBS (rollover for business start-up), you can avoid this.

This program was developed years ago, and allows you to access the funds in your retirement account tax deferred and penalty free. In fact, recently 401(k) rollover funding has been used in more than 10% of the franchises sold in the U.S.  Therefore, if you need to use savings that are in a qualified retirement plan like an IRA or (401(k), using this type of program will leave you with more capital for your multi-unit goals.

Now that you know where you are going to get the money, what is the best way to deploy it in a multi-unit funding strategy? Balancing the use of cash versus financing is critical when you are looking to fund multiple units. Outlined below are just a few of the possible scenarios, but will hopefully give you some thoughts on possible strategies.

If you have the capital to fully self-fund the opening of one unit with significant reserves left and the goal is to open three locations in 24 months consider the following:

  1. Make a 30% equity injection of the total start up costs for store #1 and finance 70% through an SBA loan.
  2. Nine months later inject 30% of the total start up costs for store #2 (if store #1 has turned profitable and you are close to or have surpassed your original projections) and finance 70% through a second SBA loan.
  3. In 12 to 18 months if store #1 is fully profitable & store #2 has broken even and is hitting projections, seek an expansion loan of stores #1 and #2 to open store #3 for 30% of the total project costs and guarantee the loan with the cash flow and assets of stores #1 and #2.

This strategy allows you to hold on to more of your personal assets and use the cash flow of the first two stores to guarantee the third location.  You can then pledge cash assets as collateral should the lender require additional collateral coverage for store #3, while allowing you to retain ownership of those assets and borrow against them at reduce interest costs. Additionally, you can still maintain 10% of your available funds for additional working capital, if needed or maintain as a safety net during ramp up and development.

If store #1 is slightly profitable and store #2 has broken even and is hitting projections:

  1. Inject 30% of the total startup costs for store #3 and finance 70% through an additional SBA loan (you would have now injected a total of 110% of opening a signal store, the ability to inject the additional 10% would come from the cash flow of stores #1 and #2, and you would have 3 stores open, not just the one you were originally able to self fund.) Assuming nether of the previous stores is in financial difficulty and both can provide a guarantee for the third location, it is still possible to obtain financing for the third store.

In almost all cases, you should seek the largest loan amount you can for store #1. Normally for a new franchise, this will be 70% of the project, depending on available collateral. This enables you to hold on to your liquid assets for cash flow in the event you need additional working capital and provide the highest possible equity injection for the second location. If sufficient time has passed (i.e.24 months) and the first two locations are doing well – obtaining an expansion loan (up to 90% of the total project costs) is possible for store #3. This is particularly true if the cash flow from stores #1 and #2 can help support the debt service for store #3. If Stores #1 and #2 can fully service the debt for store #3 then 100% financing is possible.

Every situation is unique, and personal goals are often different as well. Some entrepreneurs need the certainty that the plan they laid out is the most likely to work and won’t  rest until as much volatility as possible has been removed from the equation. Some entrepreneurs want to use other people’s money to advance their plans as much as possible and are willing to risk more uncertainty. Every entrepreneur must be understood as an individual; and what works for one may not be acceptable to another with the exact same set of financial circumstances.  The best advice is to let a trusted funding specialist review your personal financial statement, give them a thorough understanding of your goals and let them provide you with a personalized strategy for your business opportunity.

About the Author(s)

Rocco Fiorentino

Rocco brings more than 25 years of franchise experience to his new role as CEO of Benetrends.  He is a founding partner of Eagle Tax Services Group, LLC, served as president and CEO of Freedom Rings, LLC, an area developer and multi-unit franchisee of Krispy Kreme Doughnuts for PA, NJ and DE.

CFE Chief Executive Officer, Benetrends
Finance Strategy