What you need to know before applying for a franchise loan.
Franchising creates a path to business ownership that allows countless Americans the opportunity to open their own business. Unlike starting a company from the ground up, buying a franchise gets a business owner off on the right track by providing an established brand and proven business model, which reduces the risk of failure.
A franchisor provides a brand name and reputation, the product or service, operational expertise, training, materials, and advertising support. Franchisees pay ongoing fees based on sales and co-op advertising agreements. Franchising enables aspiring entrepreneurs who may have little business experience the chance to own and operate their own enterprises.
Franchising has boomed in recent years. A recent study of franchise ownership commissioned by the International Franchise Association’s Franchise Education Foundation and conducted by PwC, found that the ownership rate of minority-owned and female-owned franchise businesses have grown by more than 50 percent over the last five years. Minority ownership rate for franchised businesses increased from 20.5 percent in 2007 to 30.8 percent in 2012. The study also found that minorities were more likely to own a franchise than a non-franchised business.
Fees can range from the tens of thousands to hundreds of thousands of dollars. In return, a franchisee obtains the independence, responsibility, and potential profit associated with being in business for himself or herself. Often the biggest initial challenge is securing franchise financing. In fact, according to FranchiseHelp.com, opening a McDonald’s franchise will require $1-$2.2 million overall initial investment.
Franchise loans typically come at more attractive rates and terms than other types of small business loans. Lenders consider the financial stability, operational expertise of the business model, and previous success of the franchising corporation when reviewing the funding request.
Just as with any other type of small business loan, the prospective lender will examine a borrower’s credit rating and will expect financial data including a personal financial statement, tax returns from the past two to three years, and other information.
Small Business Administration (SBA) loans can be used for the purchase of a franchise. The most popular is the 7(a) loan program. The loans are actually issued by the SBA’s certified lending partners – usually a bank or a credit union, since the agency itself is not a bank and doesn’t lend money directly. Importantly, the SBA provides government-backed guarantees against default that mitigate the exposure to risk for the lending institutions. Roughly 10% of SBA loans are made to franchise owners in amounts that range from $250,000 to $500,000, with a maximum amount of $2 million. The funding typically is used to cover initial franchise fees, equipment purchases and working capital.
Before considering buying a franchise, here are two tips:
Make an informed decision on the type of franchise you would like to own
Don’t purchase a franchise in an industry that is saturated or trending downward. A few years ago, frozen yogurt franchises were popping up all across the country. Pinkberry, TCBY, Red Mango, Yofresh Yogurt Café, FroYo World, and Spoon Me are just a few of the competitors in the category. Every strip mall seemed to have one. Two problems: 1) strip malls are dying and 2) as a seasonal business, a frozen yogurt shop requires a big investment with only a few months of revenue-generation.
Consider your interests, aptitudes, and local prospects of success and then find out as much as you can about the franchising opportunity. Be sure to have your attorney and accountant involved in the process.
Research the financial aspects of franchise opportunities thoroughly
Find out the minimum amount of capital needed to open a particular franchise – including initial fees, construction costs, permits, equipment, inventory and staffing requirements. Any new business needs also to invest in advertising, signage, and promotion. The cost of opening a McDonald’s or KFC might simply be too steep for some individuals. If that’s the case, look for lower cost franchise opportunities.
Understand that every franchisee is required to pay royalty fees and is charged for the advertising and marketing support that the franchisor provides.
By law, every franchisor must create a Franchise Disclosure Document that provided details on the franchisor’s financial performance, an outline of the franchisees’ obligations, and financing options available. Read the document and review with an attorney be sure that you understand all the legal and financial obligations involved with a particular franchise opportunity.