Now Is a Better Time Than Ever to Land This Type of Financing for Your Franchise An economic perfect storm has created a flood of cash in the market.
By Dan Rowe Edited by Russell Sicklick
Opinions expressed by Entrepreneur contributors are their own.
Right now there is so much funding available for franchisees that there's never been a better time to start or grow a franchise business. The convergence of inflation and rising interest rates has created a situation where investors are desperate to find a place to invest their money. Inflation is at nine percent, CDs are earning a piddly three percent, and there's a contracting housing market and a stock market ripe for the bear to roar in. Investors are looking toward investing in franchises as a way to make their money work for them in today's economy.
Using other people's money to build your business has never been easier. Today, franchisees can find a patient capital investor willing to invest without interest. Here the franchisee can reinvest profits from existing stores to fund more locations. Each new location will require less capital from the investor. Now the franchisee can supplement that money with profits from the older successful stores. Once a franchisee has several profitable locations, they're able to continue to roll the compounded profits from them into new locations. All without the need for additional investor capital. Building a business through blitzscaling is the way a franchisee will get wealthy in franchising. It's also a win for the initial investor because instead of having 30 percent of a one-location business, they now have 30 percent of a multi-unit franchise operation.
For franchisees, the economy with its rising interest rates and inflation has created this perfect storm to find financing. While there is plenty of money to be had, the kind of financing a franchisee secures makes a difference. For many, equity financing is the smart choice.
Related: Considering franchise ownership? Get started now and take this quiz to find your personalized list of franchises that match your lifestyle, interests and budget.
Equity financing involves selling a portion of the company in return for capital. The advantages to equity financing over debt financing are normally that there is no repayment obligation and no personal liability or lien on other personal assets. The downside of course is that the franchisee will give up a percentage of the company. For new entrepreneurs, early-stage equity financing is often easier to secure than a traditional bank loan. While there are different types of equity financing, some of the easiest ways to get your piece of the pie are through angel investors or crowdfunding.
Angel investors
The term angel investor originated when wealthy patrons provided funds for Broadway productions. The sponsors were paid back in full plus interest when (and if) a production became profitable. The founder of the Centre for Venture Research and a professor at the University of New Hampshire, William Wetzel, christened the term Angel Investor in 1978 after completing a study on how entrepreneurs raised capital for businesses.
One of the first sources new entrepreneurs turn to for funding is friends and family. For many, getting backing from the bank of Mom and Dad is the easiest path to money. Family and friends invest because they believe in the person. But when entrepreneurs turn to professional angel investors, they're going to need a solid business plan to secure funding.
About three million angel investors are looking for strong entrepreneurs and ideas to back. I get several emails a week from angels looking for candidates to invest in. Angels typically invest anywhere from $100,000 to one million. Angel investors have poured more than $60 million into financing startups in the U.S. Angel investors are vital to entrepreneurs. They are a bridge from family and friends to private equity and venture capitalists who aren't interested in funding at this stage and for this amount of money.
The popular TV show, Shark Tank, brought the angel investing process to center stage. Entrepreneurs seeking this type of capital can learn a lot from the show about what to bring to the table to attract an angel. An entrepreneur should know their business inside and out and be able to clearly and easily articulate that to an investor. An investor will focus on numbers, so the entrepreneur better know theirs. And most importantly, the entrepreneur needs to know the valuation of their company. Never let the investor determine the valuation.
While the concept of angel investing has become more mainstream, many entrepreneurs still don't have the right idea of how to pitch an angel.
"Week after week, month after month, we meet with entrepreneurs out searching for funding. Sometimes they are successful. Often they are not," said Cal Simmons, author of Every Business Needs an Angel and my first angel investor. "Frequently the deals we see are good ones, but they are not being presented clearly or they lack a simple key ingredient. We're constantly amazed at how naïve or just ill-prepared many founders of new companies are when it comes to fundraising."
I've both received angel funding and also been an angel investor. The greatest advantage of an angel, besides the capital, is the advice and mentorship you get. I've found angel investors ranging from totally passive to as available as I've ever wanted them to be. Angel investors are as excited about the project as you are and want to see you succeed.
Related: 5 Things Your Startup Needs to Land Angel Investors
Crowdfunding
The rise of the Internet gave birth to crowdfunding in the late 1990s. Crowdfunding provides a platform for anyone to pitch an idea and for anyone to invest in it. Typically, each individual invests a small amount of money, but the total amount raised could still be six or seven figures. Equity crowdfunding, which is what a franchisee would offer, is regulated by the Securities and Exchange Committee (SEC) and became legal in 2016.
This newer equity financing is becoming popular in the franchise world. Pure Green smoothie franchise raised over a million dollars and Honeybee Burger raised $1.8 million through crowdfunding. The Honeybee Burger deal required a minimum investment of $240 and had 2,201 investors contribute in return for shares of common stock. Pure Green had more than 5,000 investors with a median investment of $100.
Crowdfunding sites like Start Engine and SeedInvest provide entrepreneurs a platform to raise money for their business. Regardless of the stage of your business, you can crowdfund. Honeybee Burger only had a virtual ghost kitchen and raised nearly $2 million to fund two L.A.-based stores and launch their company.
Crowdfunding often leads to more benefits for the brand. The Pure Green campaign became a source of franchisee leads, with about five investors converting to franchise owners. The crowdfunding campaign also drove brand awareness, and you can be sure it turned those 5,000 investors into loyal customers and brand ambassadors.
While an angel investor will take an equity stake in the company, crowdfunding franchisees can offer equity or even future equity in the company. Pure Green offered future equity, meaning that if there is ever a triggering future event like the sale of the company, these investors could make money. An arrangement like this means that franchisees don't have to give up any true equity at the time of the crowdfunding campaign. This could also be helpful down the road if the franchisee seeks additional investment because they still hold total ownership in the company.
These types of successful crowdfunding campaigns can also draw the attention of angel investors, opening up sources for additional funding if needed.
A pitfall of crowdfunding is that if the campaign doesn't receive a minimum investment, all funds are returned to investors. A franchisee using crowdfunding should have a plan to market the fundraising campaign heavily.
Related: 9 Steps to Launching a Successful Crowdfunding Campaign
Important considerations with equity financing
With equity financing, you're in essence taking on a partner in your business. This means that who is investing is as important as how much money they're willing to offer. It's imperative to evaluate your partners carefully because once they invest you can't fire them. Take your time to research any potential investor, rather than simply accepting the first offer received. You want a smart investor that adds value.
If you're raising capital, be smart about what you need. Don't raise money and give up equity to secure money you won't spend for years. You don't need funds for store number three when you first start. And if the first store is successful, you can drive the profits from it into the business to self-fund its expansion so you retain more ownership in the company. Raise the money in tranches with each tranche tied to milestones at a higher valuation. Because of your demonstrated success, you will raise money at higher and higher valuations and in the long run give away much less.
Related: 5 Things Entrepreneurs Need to Know When Raising Capital
