Should you mortgage your home to buy a franchise?
One of the earliest and most important questions potential franchisees must consider is how to finance the purchase price and start-up costs for a franchise.
While some may have cash on hand to cover all requirements, the majority will need to consider some form of finance, be that equity or debt.
When considering the best course of action for your franchise purchase, the first step is to clearly understand your net position. This means adding up the value of all of your assets, then subtracting the total of all of your debts. What’s left is your net worth.
The next step is to get a copy of your credit rating so you can understand whether financial institutions see you as a good risk.
Even if you have substantial cash holdings, it can sometimes be more sensible to use those funds to pay down other debts, than borrow to purchase the franchise, but everyone’s individual circumstances will vary so the approach needs to be tailored to meet your specific requirements.
Franchises tend to be a better risk for financiers than non-franchise businesses starting up because of their existing brand recognition, proven business model, support processes and training resources. Some banks even have lists of accredited franchises: if you’re buying one of these, your finance application may be looked upon more favourably.
For many people considering to buy a franchise, their family home is usually their single biggest asset, and is primarily used as security when it comes to borrowing. However, there are risks associated with borrowing against your home , and these risks need to be carefully considered, particularly as they relate to asset protection issues.
It is advisable to consider all forms of borrowing including non-banking such as borrowing from friends and relatives, business partners, or using other assets. Some franchises even offer their own finance options.
Financial institutions prefer to lend against residential property and will often offer cheaper rates for loans that are secured by property. While in general banks prefer property as security, some are more willing to lend against the value of the business or take other security than others.
Before deciding how much you want to borrow, make sure you have a clear picture of the costs involved, from the purchase price to the working capital you’ll need to keep the business afloat until it starts turning a profit, remembering that cash flow is king.
While it is important to borrow as much as you need so that you are not undercapitalised, it is equally important not to borrow more than you need, since this will translate to higher interest payments.
Remember, if you borrow against your home then you risk losing it if your business fails.
There are four key elements to consider before deciding whether to use your home as collateral for a franchise:
1. YOUR APPETITE FOR RISK
If you are nearing retirement age then it might not be an ideal time to potentially risk your family home. On the other hand, if you are relatively young with many years of work ahead of you then that risk may be acceptable since you have time to start again.
2. YOUR DEBT PROFLE
Can you pay off all other outstanding debts before mortgaging your family home to purchase the franchise? This can include credit cards, student loans, store cards, personal loans and any other payment plans. If you can clear all other debts then this may be more attractive to a financier.
3. OTHER ASSETS
If you have other assets of value, such as investment properties in addition to your primary place of residence, then consider these assets as collateral for your new franchise. This may be a way of managing risk to protect your primary residence.
4. YOUR EMPLOYMENT STATUS
If you or your spouse can remain employed in a day job for as long as possible after establishing your franchise, then mortgaging your home may be more acceptable. The guaranteed pay check of a steady job can pay the mortgage while you get the business established.
If you do mortgage your home, make sure you set the business up in a structure that protects your personal assets in the case of legal action or business failure. Shop around for the best interest rates, terms and conditions and type of finance that best suits your needs. This could include a combination of leasing, interest only or principal and interest borrowings.
Ultimately the choice of whether to mortgage your home to finance a franchise is a personal one that depends on your individual circumstances. If you decide to go ahead, it is vital to get professional advice to make sure you have adequately protected yourself and your family from the consequences of business failure.
Andrew Graham is the national head of business solutions for RSM Bird Cameron. With more than 20 years’ experience, Andrew has a proven record of strategy development and managing growth to deliver substantial improvements to business.
Andrew works closely with his clients to deliver results and outcomes that make a real difference to their business and personal goals.