Secured lending vs buying a business or franchise: which suits your $500,000?

Buying a franchise gives you a business and the chance to build value you can sell, but it takes your time and brings staff, landlords and operating risk. Co-funding secured loans pays 12% to 18% p.a. without running anything, but does not grow in value. It comes down to whether you want a job or an income.

This is a question HomeSec Business Finance hears often. Founded in 2004, HomeSec is an Australian private lender that invites wholesale investors to co-fund some of its short term loans. People often come to us after looking at franchises costing $500,000 or more, and then asking a simpler question: what do I actually want this money to do?

Why do people compare buying a franchise with investing?

Because the amounts are similar and so are the reasons. Someone with $500,000 to $1 million, often after selling a business or a property, or leaving a senior job, wants three things: an income, some independence, and a sense that their capital is working.

A franchise looks like a lower-risk way to get all three. The brand is known, the systems are proven and the franchisor offers support. But a franchise is still a business, and a business is still a job. Many people only discover that after they have signed.

Secured lending offers a different trade. You give up the chance to build a business, and in return you get income without the day-to-day work.

What are the hidden costs of owning a franchise?

The purchase price is only the start. Franchise owners commonly deal with:

• Staff. Recruiting, rostering, training, covering sick days and managing performance.
• Landlords. Leases, rent reviews, fit-out obligations and make-good costs.
• The franchisor. Royalties, marketing levies, required upgrades and, sometimes, disputes. The ACCC notes there is often a power imbalance between franchisors and franchisees.
• Competition. A new competitor nearby, or another franchisee in the same network, can take customers quickly.
• Reputation and complaints. One bad review, a food safety issue or a brand scandal elsewhere in the network can hit your takings.
• Earnings downturns. Rising costs, falling foot traffic or a softer economy flow straight to your profit.
• Long hours. Many owners work far more than they expected, especially in the first years.

There is also the end date. The ACCC points out that franchise agreements usually operate for a limited time, and you need to think about what happens when yours ends.

What does a business or franchise do well?

It would be unfair to stop there. A good business has real advantages that lending does not.

It can build equity. A well-run business can grow in value, and when you sell, you may get back more than you paid. A loan returns your capital and your interest; it never returns more.

It gives you control. You set the direction, choose the people and make the decisions.

It can be a lifestyle. For people who want to work, a business provides purpose, community and a role.

It can pay more in a good year. A strong franchise may earn its owner a salary plus a profit that exceeds any fixed rate.

If you want to build something and are ready to run it, a business may be the right answer.

How does co-funding a secured loan work instead?

Co-funding means lending into a specific, individual loan alongside HomeSec. HomeSec does the work: it sources each loan, assesses it against a 50-point due diligence checklist and sends you a due diligence pack. You decide whether to invest and how much.

If you say yes, the loan agreement is prepared in your name, the borrower signs with their own solicitor present, and the registered mortgage names you for your exact contribution. You transfer your money at settlement. Principal and interest are then paid directly to your own bank account.

Loans are short term business loans of 1 to 12 months, secured by registered first and second mortgages over Australian real estate, at a maximum 80% LVR on residential property and lower on commercial. HomeSec co-invests its own money in every loan it offers. Our guide to how co-funding works sets out each step.

How do the two compare side by side?

What could $500,000 earn in each?

A franchise’s earnings are impossible to state in general. They depend on the brand, the site, the manager and the economy, and they are usually quoted before the owner’s own wage.

For co-funding, the numbers are simpler. As an illustration, before tax and assuming the loan is repaid on time:

Because you choose how much to put into each loan, from $100,000, you could spread the full $500,000 across two or more loans. At the same rates, the interest doubles: $60,000 at 12% p.a., $75,000 at 15% p.a. and $90,000 at 18% p.a.

You only earn while your capital is lent, so actual income depends on how continuously you take new loans. Interest is not subject to GST, and it comes with no staff costs, rent or royalties. Our page on returns explains where the rate comes from.

What are the honest downsides of lending instead?

Lending is not free of risk, and it is not the right fit for everyone.

• Borrowers can default. A loan may need to be enforced and the property sold, which takes time. HomeSec meets the legal costs of recovery on defaulted loans, and the equity buffer below the LVR limit is there to protect your capital. The full picture is in risks and protections.
• Concentration. Each loan is tied to one borrower and one property. Because each loan can take from $100,000, $500,000 can be spread across several loans, but that is still a handful of loans rather than a pool of hundreds.
• No growth. You will not sell your loan for a profit in ten years.
• Eligibility. Co-funding is open to wholesale and sophisticated investors only.

But the risks you take are ones you can see. Each pack shows the property, the valuation, the LVR, the borrower and the exit before you commit.

Who does each option suit?

A business or franchise tends to suit people who want to work, enjoy managing people and customers, and want the chance to build and sell something.

Co-funding tends to suit people who have already built something, often a business they have sold, and now want their capital to work without them. It also suits people who are not yet sure what comes next. Because loans run for 1 to 12 months, you can earn income while you decide, and HomeSec will buy out your share if you need your principal back early. Our guide to short term investments for large balances covers that approach.

What should you do next?

Before signing a franchise agreement, it is worth asking what you want from the money and from your time. If the answer is income rather than a job, and you would like to see what a real loan pack looks like, register your interest and our Funding Manager will be in touch.