For the more than 750,000 franchise owners in the United States, many of whom are small businesses, the initial goal seems simple – turn the dream of business ownership into reality. So they go for it –and buy a franchise.
Typically, these owners are in good financial standing and rely on personal funds or can secure a loan, often through traditional channels like the Small Business Administration. They may have a bit of operating capital to support the first few months after opening their doors, and they might even have some reserves. But it usually doesn’t take long for these new entrepreneurs to realize profitability doesn’t immediately follow.
For most new franchisees, there is a one-to-two year gap before they’re in the black. Before long, the start-up money is gone and they’re leaning on personal credit and funds to stay afloat. In fact, recent research conducted by Creditera uncovered 62 percent of small business owners are using personal funds to support their business. Most go this route because they’re unaware it can damage their ability to grow, thrive and expand.
This is where the industry is focusing its time and effort: providing small business owners with more traditional and alternative lending options to bridge these gaps. But they’re missing a crucial step.
Even if business owners have access to hundreds of variations of business loans, does any of that matter if they’re not in a position to be approved? Or if they are approved, it’s only for high-interest loans or cash advances that can cripple their future cash flow. It’s like driving from Point A to Point B. What good are 20 different routes to get there if a broken down car is your only method of transportation?
At the core of the issue is creditworthiness, which can make or break a small business’s quest for financing. Many business owners are unaware of business credit when they buy their first franchise, and many do significant damage before realizing it – primarily by maxing out personal credit cards and/or credit lines. This short-term fix can lead to significant long-term damage, to business and personal credit.
Fast forward a few years. The business is finally profitable. There’s a light at the end of the tunnel and a renewed motivation to expand. However, the initial lack of awareness, understanding and proactive management of business credit will create substantial roadblocks to growth.
While personal credit plays the key role in getting financing for a franchisee’s first location, lenders will be looking at their business’s credit profile when it comes to opening more locations. They want to
see that the business itself is financially fit—not just the owner.
Traditional institutions are the typical path for franchisees to access capital, largely due to their ability to underwrite the risk of the franchisor – and with traditional financing, there is no room for bad business credit in the equation.
So how do you, as a franchisee, avoid inadvertently damaging your business credit to ensure you can access the funds you need to get your business running smoothly – and grow? Start with these four tips:
1. Separate your business and personal finances as soon as possible.
Keep your personal and business finances separate and preserve your personal credit – at all costs. Business owners likely go into business with excellent personal credit. Do everything possible to keep it that way. If you don’t and your business fails or you are sued, you risk losing your personal savings or putting your personal assets on the line. On average, business owners use at least 10 times more credit than consumers, which makes it nearly impossible to run or scale a business using personal credit alone.
2. Open a business credit card and use it.
Many business owners don’t realize they can access lines of business credit almost immediately after they open their doors. A franchisee who secured $100,000 in start-up funding, for example, may be able to access $50,000 in business credit lines right away. The beauty is that: a) it keeps you from putting pressure on your personal credit; b) carrying a balance on a business credit card doesn’t show up on personal credit reports; and c) having revolving credit on a business account isn’t detrimental to your business credit score, which many business owners
don’t realize. Using a business credit card will help build business credit and keep you from unknowingly abusing it.
3. Keep tabs on your business credit and make sure it’s actually yours.
It’s really common for franchisees to buy locations amongst each other. Since business credit is built on address and business name, this increases the chances of buying a business with a poor credit history attached. If you purchase an existing franchise, make sure your credit isn’t tied to the previous owner.
Also, monitor for confusion with other franchisees. Franchises with similar DBA names in related geographic areas frequently have their credit records crossed. Creditors could be reporting on missteps on the part of one franchisee but accidentally attributing it to your records, damaging your business credit profile without you knowing it. Multiple franchisees may also have the same vendors and creditors reporting on them, so it won’t be obvious or intuitive as to why there are negative items on a business credit report. This makes it even more important to really inspect your business credit reports.
4. Set yourself up for expansion.
Some franchisees go into ownership thinking one location will be enough. Sometimes it is. But after being in the network and witnessing the success of others, your motivation may change. So even if you don’t have your sights set on expanding – plan on it. Build your business credit, actively manage your finances and set yourself up to get the loan you may need for a second, third or tenth location. You’ll be glad you did.
Levi King is founder and CEO of Creditera, the only site giving business owners free access to personal and business credit reports, tools to build business credit and a marketplace to access financing. King is a seasoned entrepreneur and has started successful businesses in the manufacturing, hospitality, retail financial services and franchising spaces.
For more information visit: Creditera.com