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This month I will to focus on another beneficial but sometimes ignored source of financing for the franchise industry – your federal, state and local government. Government benefits can be divided into two groups. The first group is tax related benefits where a governmental agency provides some type of incentive that lowers your taxes. The second group involves direct government programs for the business community.
TAX BENEFITS
First let’s examine tax benefits afforded to franchisees who acquire property or equipment. After September 11, 2001 , the government provided significant tax advantages for the acquisition of new depreciable property, which for the franchisee primarily consists of items such as furniture, fixtures and equipment (“FF&E”). Further, to make things even more interesting, the IRS issued some new guidelines regarding what are FF&E versus building components, particularly as it relates to franchised restaurants. The real advantage is the lowering of the cost of acquisition as a result of the tax savings.
The tax savings has two components. The first component is the direct savings to the franchisee because of the lower effective cost of acquiring the equipment. This tax savings can be retained or given away through a tax or operating lease. This lease is the second tax savings component. A tax lease, as it is often called, is a lease where the lessor holds the actual ownership of the asset, and the lessee is required to make operating lease payments. At the end of the lease, if the lessee desires to purchase the assets being leased, the lessee pays the fair market value for the assets. There are a number of constraints inherent in a tax lease, but the bottom line is the tax benefits are given to the lessor and lease rates are substantially lower because the lessor receives the up front cash tax benefits. In fact, I have recently seen short term leases of two or three years that had rates close to zero because of the tax benefit afforded to the lessor.
Generally speaking, on a five to seven year lease, the rate differential between a tax motivated lease and what is known as a financing lease, can be as much as two to five percent.
There are other tax savings that reduce costs such as tip incentive credits and targeted jobs tax credits which all lower the cost of labor. There are also a number of other tax saving devices such as pretax dollars to the employee for certain meal allowances, uniforms, tools and uniform cleaning. Obviously, certain benefits such as 401(k) contributions by both employer and employee also provide significant tax benefits.
DIRECT INVOLVEMENT
The second area of government benefits is direct involvement by the government in the franchise world. The first of these, which is a great benefit to the franchise industry, are loans through the Small Business Administration (“SBA Loans”). While the qualifying amount of an SBA loan has come down and seems to go up and down on the whim of Congress, it is clear that SBA is still probably the major form of financing for the franchise industry. Franchisors should always try to be on the national registry so their franchise concept is approved for lending. Further, there are many national SBA lenders that can help move a franchisee through this process in a very expedient manner. The government’s involvement in funding the SBA has created a great source of financing for the franchise industry. Particularly for the smaller operator, it is the major source of financing for the initial acquisition, growth and development.
We have seen government involvement also in Small Business Investment Companies (SBIC’s), which are a product of the SBA. These SBIC’s are created and authorized by the SBA and have the ability, once equity is raised, to issue guaranteed bonds creating a larger supply of funding.
Many SBIC’s have been created to invest in the franchise industry. These SBIC’s are either investing in the form of pure equity, which is a very needed type of money for the franchise industry, or they are providing what is known as mezzanine debt. Mezzanine debt is unsecured or subordinated debt at a high but effective interest rate.
The incentives the government provides have allowed for formation of these SBICs and further have provided money to the franchise community.
Finally, states and municipalities throughout the country recognize the need for urban redevelopment and rural economic development and are affording unique economic incentives. Laws and opportunities vary tremendously from state to state. One significant opportunity may be a reduction or elimination of real estate taxes for new business development, particularly real estate intensive development. Some states have set up enterprise zones in urban areas as well as rural areas that may have minimal taxes for businesses in these zones. There are also government incentives for re-development particularly in distressed urban areas. The franchise world is finding a potential source of development is the inner city and rural areas due to the low cost of real estate and high government incentives. These areas may be competitive with traditional suburban areas.
The above is not an all-inclusive list but merely some ideas for you to consider when planning the costs of your capital and financing needs. Please consult with your tax and finance professionals to learn more how the federal, state and local government can help meet your needs.
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