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Chapter 4. Service Delivery System and R... > Lowering the Cost of Capital

Lowering the Cost of Capital

In addition to being used as the platform for the SDS, real estate can also be used to lower the total cost of the capital for starting your franchise. This is accomplished because debt is cheaper to obtain than is equity, and real estate is most often financed with a mortgage. Because the debt is asset-based (i.e., the debt is collateralized by the real estate), it is often at a more favorable interest rate than a nonasset-based loan because the risk is lower for the bank. A potential opportunity to lower the bank’s risk and perhaps the cost of debt is to show several alternative uses for the property should the business go into default. The easier it is for the bank to sell the property to someone else if you fail, the lower the perceived risk and the lower the interest rate charged. If the bank is reluctant to grant a lower interest rate, then, at least this will help to increase the probability of getting capital. For example, when attempting to get financing, Jiffy Lube franchisees were given a handbook from the franchisor that outlined 100 alternative uses for Jiffy Lube real estate in the event that a unit failed, and they were encouraged to share it with the bank during financing negotiations.

Real estate can also be used to a great extent as a means of “engineering” financial strength through off-balance-sheet leasing. Owning real estate off the balance sheet is achieved by establishing an entity like a real estate partnership to buy the real estate and lease it back to your operating company. Some advantages include the ability to separate the real estate from the business upon sale, added protection from legal liability, and the option for you to extract wealth through aggressive lease rates when the business does well.


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