In the next segment, Spectrum of Franchising, we’re going to look at the four primary categories where most franchises fit into. But before we do that, it’s important to understand where the funding for each of those categories will come from. So right now, we’re going to focus on franchise funding sources.

As we’ve already touched on, typically franchise fees and working capital are financed with a combination of cash and lines of credit—in other words, from your personal resources. Small business loan financing is relatively easy to get for the hard assets, such as the build-out, equipment, and leasehold improvements.

The type of business you buy will ultimately determine what portion of the investment will need to come from your personal savings and investments, and what portion can be financed.

The Canada Small Business Finance Program is a program offered by the federal government through the major banks. With this program, you can borrow up to $350,000 for each company or location. The neat thing about it is that the government guarantees that loan to the bank for 75% of the total investment.

There are strict criteria for this type of loan, though. It’s only for capital expenditures and equipment—build-out of the location, etc. You cannot use it for franchise fees, working capital, inventory, or training fees. All of that has to come out of your personal savings or other personal funds.

Banks can offer regular term loans, but they’ll rarely finance working capital. This is where the BDC (Business Development Corporation) comes in. BDC is a Crown corporation that only works with businesses. With BDC, you can borrow up to a certain amount on signature and personal guarantee alone. You’ll want to check with BDC what that current amount is. If you want to go higher than that amount, BDC will provide that kind of financing, but only if you provide personal security for that loan amount—second mortgage, stocks, things like that.

With service-based businesses, where you’re operating out of your home or a small location where there are not a lot of capital expenditures, these businesses don’t qualify for the Canada Small Business Finance Program. So, you have to fund them yourself.

The most common form of funding is a home equity line of credit, or what we call a HELOC. If you have good equity in your home and a good credit score, HELOCs are one of the easiest forms of financing to get, and it’s one of the least expensive forms of financing. So, they’re very, very popular for funding small businesses.

Friends, relatives, your partner—this is a common form of financing. We call it love money. But if not structured correctly at the beginning, it can lead to a lot of future relationship challenges.

Some of the things, if you’re going to use this type of financing, that you want to get clarified and documented upfront: be sure that whatever the terms and agreements are, they’re clearly defined and documented—ideally with a lawyer. Do you want it to be just a loan, or is the person providing the funds going to be an equity partner? If they are going to be an equity partner, how much control do they have? These are contentious issues that often get overlooked, and that’s why there are relationship challenges.

Seller financing is typically not applicable to the vast majority of franchise options—unless you’re going to buy an existing franchise that’s up for sale. Then you’ll get the financing from the person selling that business.

The last form of financing that we’ll discuss here is RRSPs. Unfortunately, in Canada, there’s no program where you can convert your RRSPs into investing in a business tax-free. So, there are severe penalties for taking money out of the RRSP to launch a business. We don’t recommend that you do that.

The only time we see clients using RRSPs to fund their business is after they’ve bought the business. They use the RRSPs to cover those monthly expenses through that launch year. Think about it this way: if you’re not drawing money from the business, your income is going to be zero. So, if you take $4,000 a month out of your RRSP to cover those monthly expenses, then you’re going to be taxed at that lower tax rate. It is one cash flow strategy after you’ve launched your business.