Franchise owners get support from larger, established companies, but that comes at a cost. The initial investment for a single unit varies, with some business owners having to pay well over $100,000 for a franchise unit per the terms of the franchise agreement. After making the initial investment, you may still need financing to help with salaries, new locations, and equipment. However, understanding financing options promotes sustainable growth and helps you avoid getting burned by debt. We’ll share several franchise financing options and how they can help your business.
What is Franchise Financing and How Does It Work?
Small business owners often use loans to cover initial costs and to expand operations. Opening a franchise is a significant investment, and not everyone has enough funds to cover the expenses, but franchise financing helps business owners get started. Franchises may become less reliant on loans as they grow and become more profitable. However, financing can help in any part of your franchising journey, especially the initial stages.
Things To Consider Before Opening a Franchise
Opening a franchise isn’t for everyone, as this business model requires significant time and capital. You get help from a reputable brand, but it’s considerable work. Consider these factors before entering the franchising business:
1. Assess Your Situation
Your initial financing needs depend on the franchisor’s requirements. For example, some franchises require a 10%-30% down payment, and the total bill will also determine how much you need to borrow. Therefore, business owners should assess their finances and the opportunity before getting a business loan.
2. Consider How Much You Need
Higher franchisor minimums mean you’ll have to borrow more money to get started. The higher loan amount comes with higher monthly fees, but you can opt for a lengthier loan term to mitigate the loan’s impact on your finances.
3. Costs Of Opening a Franchise
You will have to pay a franchise fee to enter the industry. Some franchisors offer installment payments, while others request a lump sum. This fee covers the rights to operate under the franchisor’s name. You’ll get instant brand recognition if you work with a reputable company. After paying this fee and getting the property, you’ll still have to pay royalty and advertising fees. Franchisors will collect a percentage of sales and allocate those proceeds for ads and other promotional efforts.
4. How To Spend Your Franchise Funding
The loan lets you enter the franchise industry or expand operations. You can use the financing to afford the equipment, pay salaries, and promote your franchise. Before getting funds, create a franchise business plan, so you use the loan proceeds wisely.
Franchise Financing Options
Aspiring franchise owners and experienced entrepreneurs can use several financing options to start and expand their franchises:
SBA 7(a) Loans
The U.S. Small Business Administration offers many business loans, such as 7(a) loans, which are useful launchpads for aspiring franchisees. While these loans take more time to receive and have more requirements, they have desirable interest rates. You can borrow up to $5 million and pay it back under a 10-25 year loan term. Make sure you register your business into the SBA Franchise Directory if you want this loan.
SBA 504/CDC Loans
These SBA loans primarily serve business owners looking to buy real estate or equipment. An SBA 504/CDC loan has less flexibility about how you can use funds, but you can borrow up to $20 million. Borrowers can pay back the loan under a 10-25 year term. You will need to register your franchise with the SBA Franchise Director for this loan.
Franchisor Financing
Some franchisors offer financing to support franchisees. Franchisors want to make it easy for ambitious business owners to grow their franchises, so they’ll offer guidance and attractive rates to their franchisees as incentives. In addition, some of these entities make the process easy to understand and provide discounts for performing specific actions (i.e., opening multiple branches).
Commercial Bank Loans
Banks offer commercial loans to franchisees. While these loans have competitive rates, it’s not easy to get one, as bank lenders will ask for a business plan and require good credit. Each bank has different loan limits based on its available funds. Asking for a loan amount well below this limit will increase your chances of securing a loan.
You can use the FDIC’s BankFind Name and Location Search tool to see the total amount of assets held by any commercial banks in the United States. These funds are part of a capital account, and commercial banks typically use 6%-8% of those funds to finance loans. However, commercial banks can’t let you borrow more than 15% of their capital account funds.
A bank with $100 million in assets may have $6 million in its capital account. It can’t let you borrow more than 15% of those funds, putting the loan limit at $900,000. This issue doesn’t come up for most borrowers, but you should ask banks about their loan limits if you want to borrow millions of dollars for your franchises.
Crowdfunding
Some franchises leverage the public market for financing. You can incentivize people with exclusive rewards and early access via financial contributions. Additionally, listing your crowdfunding project on popular sites can increase your visibility and lead to more contributors.
Small Business Credit Card
Small business credit cards give you access to a revolving line of credit. You can borrow against it anytime you desire, and you don’t pay interest until you tap into the funds. You can also use a small business credit card to finance your franchise’s expenses. The major downside of credit cards is the high-interest rates. Small business credit cards work best for short-term financing, but they can also cover essential expenses if you need an extra funding source.
Equipment Financing
Equipment is a necessary asset for most franchisees. The right equipment increases productivity and delivers better products and services to customers. Equipment financing helps franchisees who only need equipment.
How to Apply for Franchise Financing
Franchise financing gives your ambitious project a foundation. Here’s what you’ll need to apply for a loan:
Personal Credit History
Credit history reflects a borrower’s ability to manage debt, and most lenders will ask for your personal credit history because of this. Paying back late debt and staying on time with future payments are the best ways to improve your credit history before approaching a lender.
Basic Personal and Business Information
Lenders will ask for some basic information during the application process. You can expect to provide the following:
- Social security number, background information, and ID
- Resume
- Proof of ownership
- Time in business
- Licenses and permits
- Other legal documents
Financial Information
Credit history assesses your ability to manage your current debt. Your financial information reveals your capacity to handle a new obligation. Lenders will review the following documents:
- Personal and business tax returns
- Bank statements
- Balance sheet
- Income statements
- Any debt
Lenders may review 1-3 years of your financial documents to ensure your income and other details are consistent and trending in the right direction.
Franchise Information
Franchise financing carries an extra parameter. Lenders won’t stop at reviewing your financial health; they will also analyze the franchise itself to ensure they are funding a reliable business model.
Business Plan
If financial institutions like the franchise, they’ll proceed to read your business plan. Not every franchisee launches a successful franchise, and lenders understand this risk. They will assess your business plan and consider your experience before providing you with a loan.
Down Payment
Most lenders will request a down payment. Most of these initial payments range from 10%-30%. Start saving for the down payment if you are far off from securing a franchise, as you’ll have more flexibility by the time you have to pay.
Frequently Asked Questions
Below are some frequently asked questions regarding franchise financing to help you make an informed decision.
It depends on your company’s financial health and how long you’ve been in business. If you’ve recently opened the doors or have subpar credit and minimal revenues, you will likely face challenges when applying with a traditional lender. However, a direct or online lender may be willing to work with you despite your low credit score or lack of business experience. Consider using an online lending marketplace that can shop your information around to possibly identify lenders who can possibly assist you with your franchise financing needs.
Most lenders will check your personal credit score when applying for franchise financing unless you’ve been established for some time, and they have financing options available with no personal guarantees. The most competitive financing terms are reserved for borrowers with strong credit ratings, and traditional banks are often reluctant to extend funding to business owners with lower scores due to the risk of default. However, you may have more luck with a direct or online lender if your credit score is perfect – a 680 or higher will give you higher approval odds and help you access better financing terms.
Yes, franchise financing is available through traditional banks, credit unions and direct lenders. But as mentioned above, direct lenders tend to be more lenient in terms of eligibility requirements and could be a good fit for less-experienced franchisees or business owners with past credit challenges.
Shop around with traditional banks, credit unions, direct lenders and online lenders to determine which offers you the best deal on franchise financing. But if you settle for the first opportunity that comes your way, you could be missing out on a better deal and settling for far higher borrowing costs than you need to pay based on your company’s financial profile.
Remember, an online lending marketplace or search tool can make it easier to scope out your top funding options. Or you may find that another form of financing, like a term loan or term loan line of credit, is far more suitable for your company.
