Many franchise systems require prospective owners to have a certain amount of “liquid capital” or “liquid assets” to qualify for investment. But what exactly constitutes liquid capital, and why is it an important financial requirement for franchising? This guide examines the definition of liquid capital, why it is required, how franchisors evaluate it, and tips for boosting your liquidity.
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Liquid Capital Defined
Liquid capital refers to cash, assets, and investments that can quickly and easily be converted into cash in a short period of time. Liquid capital includes:
- Cash in bank accounts or savings
- Stocks, bonds, and investments
- Cash value of life insurance
- 401K or IRA retirement funds
- Trust funds or inheritances
- Proceeds from selling other properties
The essential quality is having unfettered access to the capital to fund business investment and startup costs quickly. Assets must be liquid and not tied up in other areas.
Why Liquid Capital is Required
Franchisors require candidates to have minimum liquid capital for several key reasons:
Fund Startup Costs
Liquid funds ensure franchisees can cover all initial buildout, equipment, inventory, training, marketing, and launch costs to open. This startup phase often runs $100,000 to $1,000,000+ depending on the concept. Bank loans alone rarely cover the full amount.
Cover Operating Losses
New franchises often lose money initially as sales stabilize. Liquid reserves ensure franchisees can float operating losses and expenses until the unit breaks even, which may take months or years. Enough liquidity prevents insolvency.
Align Incentives
Requiring franchisees to invest a substantial portion of personal capital ensures they share risk and are financially committed to diligent startup and success of the business.
Asset Buffer
Liquid capital reserves act as an asset buffer in case the franchise underperforms, needs expensive emergency maintenance, or must be closed. This provides franchisees greater flexibility to take action as needed. Essentially, liquidity equals security.
In short, franchisors require liquid assets to qualify franchisees because it demonstrates financial means, commitment, and motivates diligent operational execution. Liquid capital is tied directly to increasing the odds of franchise success. Undercapitalized units fail more frequently.
Typical Liquid Capital Requirements
While specific liquid capital requirements vary by franchise system, common ranges include:
- Fast Food Franchises – $500,000 liquid capital
- Full Service Restaurants – $750,000 – $1 million
- Hotels – $1 million – $5 million
- Retail Franchises – $100,000 – $300,000
- Home Services Franchises – $50,000 – $150,000
The required liquid amount is determined based on covering estimated startup costs plus reservoirs to operate at a loss for 6-12 months as the unit stabilizes. Historical expenses and losses for current franchisees in the system are analyzed to set liquid minimums prudently.
How Franchisors Evaluate Liquid Capital
Franchisors carefully scrutinize candidate financial documentation during vetting. Be prepared to provide current account statements and details proving liquid asset levels including:
- Bank Accounts – Business and personal checking/savings account statements providing current balances.
- Investment Accounts – Brokerage and fund statements documenting stocks, bonds, and other securities you can liquidate.
- Retirement Accounts – 401(k), IRA, SEP Plan, Keogh Plan statements with current balances.
- Property Values – Documentation proving value and equity for any real estate you may sell.
- Other Assets – Trust fund values, inheritances, business assets to be sold, etc.
- Liabilities – You must also disclose all loans, mortgages, business debts, taxes owed and other liabilities that reduce liquidity.
Franchisors will scrutinize account balances, requiring updated documentation. Assets must be proven, not just pledged.
Tips for Improving Liquid Capital
If your current liquid reserves fall short, options to boost liquidity include:
- Save diligently – Commit to adding to cash savings monthly until reaching the target franchise amount.
- Sell assets – Sell cars, boats, RVs, valuables, or second houses not needed.
- Pay down debts – Paying off loans improves cash flow available for savings.
- Refinance debts – Refinancing credit cards or loans at lower rates often allows directing more cash to liquid accounts.
- 401(k) loan – Some plans allow borrowing against a portion of 401(k) balance.
- Home equity loan – Tapping available equity to free up funds.
- Business loan – Securing financing against current business assets.
- Rollover for Business Startups – Allows using 401(k) funds for business.
- Private capital – Seeking investment from friends, family, private individuals.
With perseverance and a prudent plan, prospective franchisees can methodically improve liquid asset levels over time to meet capital requirements.
Using Retirement Funds
One of the most substantial sources of liquid capital for potential franchisees is often retirement accounts like 401(k) plans or IRAs. Using these funds requires caution:
- Consider implications – Withdrawals may impact your retirement runway. Weigh risks carefully.
- Follow rollover rules – Those under age 59.5 must follow IRS guidelines to avoid penalties.
- Get guidance – Consult financial advisors and franchise CPA to ensure proper procedures.
- Limit withdrawals – Don’t liquidate 100% of retirement funds which leaves no savings buffer.
- Have reserves – Keep some cash reserves separate to cover retirement living expenses.
For younger franchisees, limited living expenses may provide more flexibility to cautiously utilize retirement funds. But consult tax professionals first.
Adding Partners
Another option to boost liquid capital is adding partners or co-investors to pool funds together.
- Evaluate capabilities – Ensure any partners bring strategic experience, not just capital.
- Define roles – Clearly outline responsibilities, equity splits, decision rights contractually upfront.
- Check egos – Partners must be able to collaborate without ego conflicts derailing the business.
- Maintain control – As primary founder, consider maintaining 51%+ equity control if possible.
- Start slow – Begin as minority partner to assess commitment first before deeper integration.
Having co-investors can immensely strengthen your franchise application. But ensure their capabilities, integrity and vision aligns fully.
Using Home Equity
Since home values have appreciated substantially nationwide, many franchise candidates strategically access home equity to provide liquid funds via:
- Cash-Out Refinancing – Refinancing into a larger mortgage to withdraw accumulated equity.
- Home Equity Loan – Separate second loan or line of credit borrowing against equity.
- Home Equity Line of Credit (HELOC) – Revolving line of credit based on equity. Flexible drawdown of funds.
Utilize equity strategically only for the franchise opportunity. Avoid putting your home needlessly at risk. Analyze the business merits diligently.
FAQ About Liquid Capital
Here are some frequently asked questions:
How is liquid capital different from net worth?
Net worth includes all assets like houses, cars, property, etc. Liquid capital is just the cash and assets immediately available without contingencies.
Can I use my house or other properties?
Indirectly by taking loans against the equity. Franchisors want to see cash accounts, not illiquid assets like real estate.
What if I fall short of capital requirements?
Some may allow partners or SBA loans to cover shortfalls. But lacking sufficient capital can swiftly disqualify you.
Do franchisees have to be wealthy?
No, but adequate capital reserves are crucial. Undercapitalization is a top factor in franchisee failure. Creative financing and partnerships can assist those with limited means.
Can I finance the full franchise investment?
Most require 25-40% liquid funds as your equity contribution. Loans cover remaining amounts in many cases.
What is considered a strong liquid capital amount?
$250,000 – $500,000+ in unfettered cash is ideal for most franchises as it covers startup costs and provides operating reserves.
Maintain Access to Sufficient Capital
Liquid capital marks a defining franchise qualification criterion due to the essential financial security and motivation required to launch a successful franchise unit. Take steps to document and grow your liquid reserves in preparation. Adequate capitalization marks the difference between draining hardship and strategic growth for new franchisees. Partner with a brand suited to your current means and track record.
