2020 was a problematic year for many businesses. The COVID-19 pandemic created a volatile business environment across the United States. Many people lost jobs while others struggled to make ends meet. The uncertainty following 2020 has influenced some individuals to bet on themselves by purchasing a franchise.
Starting a business requires a solid financial plan. Part of the plan may include leveraging some of your 401(k). But is it a good idea? Here to talk about this issue is Bill McPherson, vice president of franchise development for AlphaGraphics, a leading franchisor of printing and marketing solutions.
Franchise Chatter (FC): After getting through a volatile work and business climate in 2020, why are people turning to purchasing franchises in 2021?
Bill McPherson (BM): What I’ve seen over my career is that when we go through challenges like this, whether it be a new administration in the White House, economic downturns, volatile unemployment rates, or, in this case, COVID-19, people tend to look through a different lens. So rather than waiting for the next corporate layoff or watching their 401(k) go down every month, they say, “You know what, I’m going to invest in myself and a business.” Often, an appealing pathway for them is a franchise because it eliminates much of the risk.
FC: What are some of the risks of using your retirement savings to purchase a franchise?
BM: Whether it’s the retirement savings or getting a (Small Business Administration) loan or using a severance package, there are inherent risks in starting any business. If you go the franchise route, it can eliminate a tremendous amount of that risk. Using this method, there is a chance that the retirement funds invested can be lost, but studies show that your success rate as a franchisee vs. an independent business is overwhelmingly higher if you find the right franchise brand, support and training.
At AlphaGraphics, we have seen people use part of their 401(k)s as a funding source many times. Their funding strategy may be a multi-channel approach. They may get an SBA loan, they may put down X amount of cash, they may fund the rest from their 401(k). It’s not using all of the 401(k) to buy the franchise outright, but it’s a portion. That helps eliminate some of the risks from their perspective as far as leveraging their 401(k)-retirement savings.
But there is always going to be a risk when leveraging your retirement to help fund a franchise. Nothing is guaranteed in any business venture. If the business fails, you are also potentially losing a large portion of your retirement. Before taking out a loan or rolling over your 401(k) for business purposes, you should consult with a financial advisor or tax professional.
FC: What are some of the advantages of leveraging your 401(k) to purchase a franchise?
BM: That’s part of the strategy. They’ve got the money there. In an environment like we just came out of in 2020, a lot of people’s 401(k)s have been decreasing. They are unsure of what 2021 will have in store for their retirement plans, because of COVID or the new administration, etc. One of the advantages that candidates see is controlling their destiny more and taking their money and investing in their own business and themselves. Candidates who make for good entrepreneurs typically like that element of control.
It’s a very viable strategy. Fifteen years ago, people thought that it was a scam or wasn’t legal. That’s absolutely false. Not only is it legal, 40-50% of new franchisees that we’ve launched are leveraging their 401(k)s. So, it’s a viable strategy. It just depends on the personal situation.
FC: Other than the advantages and disadvantages we discussed, what are some things franchise buyers should consider when deciding whether or not to leverage their 401(k) on a franchise?
BM: That is going to be different on a case-by-case basis. It’s a personal decision. What do their total assets look like, how much home equity do they have, how much liquidity? It’s going to be different for each person. If 95% of their net worth is tied up in their 401(k), that’s one decision. If 20% of their net worth is tied up in their 401(k), it’s a different decision. So, I believe it depends on each particular situation or family.
FC: What are some other alternative funding methods when buying a franchise?
BM: It really depends on the franchise. How long has the franchise been around, what banking relationships do they have in place? At AlphaGraphics, we’ve been around for 51 years and have a very strong track record on the franchise model. So, we are a preferred franchise model with the SBA. We can help potential franchisees access lenders all across the country. We have seen people use SBA lenders, conventional lenders, home equity lines of credit, and unsecured lines of credit. It really all depends on the franchisor, but there are many different pathways for a franchisee to fund their business.
Bill McPherson is the vice president of franchise development for AlphaGraphics, a leading franchisor of printing and marketing solutions. With more than 285 locations in 6 countries, AlphaGraphics is one of the largest U.S.-based networks of locally-owned and operated Business Centers offering a complete range of print, visual communications, and marketing products. For more information, visit www.alphagraphicsfranchise.com