Getting a Loan to Open a Franchise Gets Harder
When Rick Kimsey decided to start a business, a franchise seemed like the best way to go.
Buying a franchise — in his case, a Doctors Express urgent care facility — meant he didn't have to start from square one. The business came with a concept and a service to sell. Urgent care centers treat a range of common non-life threatening medical conditions such as colds, sprains, broken bones, rashes and stomach ailments — usually without an appointment. For many people, the facilities are more appealing and less expensive than a trip to the emergency room. Kimsey just needed to get the franchise up and running, and then operate it. It didn't even matter that he had no medical training.
But what sounded like a great plan wasn't so easy.
Financing for the business was nearly impossible to get in the aftermath of the 2008 financial crisis and the recession. Kimsey was dealt his first blow when his bank froze his home equity line of credit. Then six banks turned him down for a loan. (Read more: The Financial Crisis: This Day—September, 2008.)
"The rug was pulled out from under me," Kimsey says. It took more than a year before he was finally able to close the deal.
The tough economy has made the prospect of operating a franchise attractive to the unemployed, to workers who don't want to wait to get knocked off the corporate ladder and to others looking for a new way to generate income. (More: Why Fewer Americans Are Starting New Businesses.)
But first-time franchise buyers are finding it's harder than they expected to cobble together the money needed to get their businesses off the ground. Lenders are rejecting them because of their inexperience or because the franchises they're buying are relatively young and not as well-known as established brands such as McDonald's and Jiffy Lube.
Kimsey was attracted to Doctors Express because health care is one of the fastest growing franchise segments. He had spent nearly 20 years in the wireless telephone industry. He decided to leave that business because the mega-mergers in wireless meant it was getting harder to find investors for new ventures. When he knew that he wanted to open a franchise, he considered one that's technology-related, Batteries Plus, which operate stores that sells batteries of all kinds.
But "I was looking for a sizzling sector like cell phones were in the `80s," he says. So he decided on Doctors Express.
He had enough of his own money saved for a $55,000 payment, known as the franchise fee, to the parent company. And he won approval to open the franchise in Sarasota, Fla. He needed $1.2 million to cover between $250,000 and $300,000 in construction costs, $150,000 for equipment and the remainder for working capital.
Banks Reject Loan Application
The banks that rejected his loan application gave similar reasons for saying no, he says.
"It's a fairly new franchise. This isn't McDonald's, so we don't have 70 years of history," Kimsey says. Doctors Express was founded in 2005 and has 54 locations. McDonald's has more than 14,000 restaurants in the U.S., and about 90 percent are franchises.
And even though the company doesn't require that franchisees have medical training, the banks were uncomfortable with the idea.
"It's a franchise concept where you don't have to be a doctor to own it. It's outside their thinking," he says. The banks liked his business plan, but bank officers told him that because he wasn't a doctor, "that's going to be a problem."
There was more: "We don't have a lot of assets. It's not like I have a million-dollar CAT scan" that could be used as collateral, he says. He leases the building and equipment like an X-ray machine.
Eventually Kimsey did get a $575,000 Small Business Administration-guaranteed loan from a bank in Utah. He tapped into his savings and about $500,000 from his 401(k) — the entire account — for the rest of the money.
"I've got to build this up. It will be my retirement," Kimsey says of his franchise. "Then I'll hand it over to my children."
Franchises have suffered along with other small businesses in the last five years. (More: Questions to Ask Before Buying a Red-Hot Franchise.)
The number of franchises in the U.S. — for example, an individual McDonald's, Dunkin' Donuts shop or Days Inn — fell by 37,790, or nearly 5 percent, between 2008 and 2011, according to the International Franchise Association. The trade group estimates that the number of franchises will rise this year for the first time since 2008, gaining 1.7 percent to 748,680. But that's still more than 3 percent below 2008's 774,016.
The number of franchises dropped as the recession (learn more) made many people were wary about starting a business and because thousands of franchises closed, among them auto dealerships and real estate brokerages. High-end restaurant franchises were also hit hard — the restaurants in the Steak & Ale chain were among the franchises that shut down.
"Where it's really having its hardest effect is the aspiring entrepreneur who doesn't have that track record or that relationship with the banks," says Stephen Caldeira, president of the International Franchise Association.
But banks are also wary about franchises they're unfamiliar with — the problem that Kimsey ran into. That's a huge change from before the recession.
Are Franchises a Sound Bet?
"Prior to 2008, there was the general view of franchisees and the lending community that franchising was a fairly sound bet," says Darrell Johnson, CEO of FRANData, a research firm. "The rising economic tide would float all boats, and one brand might not be as strong as another, but everyone was going to do OK."
Now lenders are asking more questions about the brand, Johnson says. That's happening even in some of the franchise industries that are most popular now, including health care, elderly care and gyms and other fitness companies.
"The credit score that used to guarantee a loan doesn't anymore," says Peter Ross, CEO of Senior Helpers, which has 300 franchises that provide in-home care to the elderly. As a result, "people have to be a lot more creative" to raise money to buy a franchise. He sees more buyers tapping their 401(k) accounts. (More: Postponing Retirement Indefinitely.)
Most of the successful buyers tend to be those who already own franchises and have a credit history to show the banks. Private equity firms that have their own money and don't need to go through a bank are also buying.
More Hoops for First-Timers
First-timers can find themselves jumping through an increasing number of hoops.
When Scott Gow decided to open a UPS Store franchise in the Denver area, he applied to a bank recommended by United Parcel Service Inc., but the bank kept raising the amount of his own money it wanted him to put up. Gow says he's not sure why the bank kept demanding more from him.
"I got to a certain point where I wasn't comfortable," he says. "I could have financed the business myself."
That is what he ended up doing, not only out of frustration, but because he was laid off from his job with a government contractor and knew that there was no way he would qualify for a loan at that point. He uses his 401(k) to cover the costs of renovating, furnishing and stocking the store.
Banks Make More Demands
Other UPS franchise buyers have had a similar experience with banks, says Chris Adkins, the company's vice president of sales. "I don't see a tremendous amount of rejections" by banks, he says. But the loan application process is so painful, with banks making more and more demands that some buyers decide to finance the purchase on their own.
Gow did get a break from UPS because he had been in the Air Force for 24 years before leaving in 2001. The package delivery company waived the nearly $30,000 franchise fee under a program called Operation Enduring Opportunity that was launched in 2011 that helps veterans open franchises. Gow hopes to have the store open next month.
Some would-be franchisees are turning to relatives for help. Christian Brantley and Jessica Mitchell were able to finance the $15,000 franchise fee and construction costs themselves when they bought a Snap Fitness gym near Willis, Texas, about 40 miles from Houston. But they were turned down for $170,000 in financing to lease about 75 treadmills, stationary bikes and other equipment from the manufacturer. The reason: They were too young. When they applied, Brantley was 23 and Mitchell, 24.
"We have no equipment," Brantley recalls thinking. "We are going to have a yoga studio for a year."
The solution was for Mitchell's father, a real estate developer, to be their guarantor on an application with another equipment maker. They got their machines for the same amount, $170,000. The gym opened in March, three months later than expected.
Without help from Mitchell's father, Brantley says, he'd be "freaking out."