Financing Strategies for Multi-Unit Operators

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

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 an entrepreneur funds the first unit affects his ability to fund the future units. In other words, if arranging financing for the first unit without considering how it is going to affect his ability to get additional financing, he may find himself without any options to fund the 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, which is typically a SBA loan. Let’s start with where someone is going to get the money needed. Asking for a loan from friends and family is a popular strategy, but if someone believes what William Shakespeare wrote in his play “Hamlet,”“Neither a borrower nor a lender be; for loan oft loses both itself and friend,” borrowing from friends and family may not always be the 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 they are certainly harder to get. In many cases, the equity has vanished as home values have decreased. That leaves entrepreneurs with using their personal savings or possibly utilizing their 401(k) funds in conjunction with Small Business Administration funding.

If someone has sufficient funds in the bank to either fund a project entirely or enough for the capital injection for a loan, that individual is in great shape to move forward. However, many entrepreneurs today have the majority of their savings locked away in retirement plans such as IRAs and 401(k)s, which carry severe penalties and tax consequences for early withdrawal. For example, if an individual has $200,000 in an IRA or 401(k) and takes an early withdrawal, he may be required to pay a 10 percent penalty and as much as 30 percent in ordinary income taxes, leaving only $120,000 of the original $200,000. The last thing anyone wants to do when starting a business is to lose 40 percent of the working capital paying taxes and penalties on his savings. Fortunately, by utilizing a popular strategy known as a 401(k) ROBS or rollover for business startup, people can avoid this.

This program was developed years ago, and allows participants to access the funds in their retirement account tax deferred and penalty free.

Recently, 401(k) rollover funding has been used in more than 10 percent of the franchises sold in the United States. Therefore, if someone needs to use savings that are in a qualified retirement plan like an IRA or 401(k), using this type of program will leave the individual with more capital for multi-unit goals.

Now that the entrepreneur knows where he is 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 someone is looking to fund multiple units. Outlined below are just a few of the possible scenarios that will provide insights on possible strategies.

If an individual has 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, she might consider the following:

  • Make a 30 percent equity injection of the total start-up costs for store No. 1 and finance 70 percent through a SBA loan. 
  • Nine months later, inject 30 percent of the total start-up costs for store No. 2 (if store No. 1 has turned profitable and is close to or has surpassed the original projections) and finance 70 percent through a second SBA loan.
  • In 12 to 18 months, if store No.1 is fully profitable and store No. 2 has broken even and is hitting projections, seek an expansion loan of stores No. 1 and 2 to open store No. 3 for 30 percent of the total project costs and guarantee the loan with the cash flow and assets of stores No. 1 and 2. 

This strategy allows the owner to hold on to more of his personal assets and use the cash flow of the first two stores to guarantee the third location. The owner can then pledge cash assets as collateral should the lender require additional collateral coverage for store No. 3, while allowing the owner to retain ownership of those assets and borrow against them at reduced interest costs. Additionally, the business owner can still maintain 10 percent of the available funds for additional working capital, if needed or maintain as a safety net during ramp up and development.

If store No. 1 is slightly profitable and store No. 2 has broken even and is hitting projections: 

  • Inject 30 percent of the total start-up costs for store No. 3 and finance 70 percent through an additional SBA loan. The business owner would have now injected a total of 110 percent of opening a signal store and the ability to inject the additional 10 percent would come from the cash flow of stores No. 1 and 2. The owner would have three stores open, not just the one he was originally able to self fund. Assuming neither 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, seek the largest loan amount possible for store No. 1. Normally for a new franchise, this will be 70 percent of the project, depending on available collateral. This enables the owner to hold onto liquid assets for cash flow in the event he needs additional working capital and it provides 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 percent of the total project costs) is possible for store No. 3. This is particularly true if the cash flow from stores No. 1 and 2 can help support the debt service for store No. 3. If stores No. 1 and 2 can fully service the debt for store No. 3, then 100 percent 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 the specialist a thorough understanding of your goals and let the specialist provide a personalized strategy for your business opportunity.

Dallas Kerley- Chief Development Officer, Benetrends
Kerley is CDO at Benetrends, a leading firm that specialized in franchise and small business funding solutions. He is a frequent presenter at small business events, educating entrepreneurs on small business funding strategies and was formerly Managing Director at Knott Capital Management, an equity investment advisory firm.  |  @benetrends  |   |  866.423.6387