Franchise Business Loan: What You Need to Know

Approximately 1 out of every 12 businesses in the U.S. is a franchise business, according to AZFranchises. Opening a franchise is an exciting venture that can often lead to financial success, but a lot can go wrong if you’re not prepared, especially when it comes to franchise loans.

You don’t want to risk making a mistake when it comes to buying a franchise. Here are 5 loan pitfalls for small business owners to avoid when buying a franchise, regardless of what kind of credit and experience you have:

1. Neglecting to Research

Franchising doesn’t guarantee you a successful business. As a new franchisee, you are about to become a business owner, and as a small business owner, you need to have the in-depth knowledge of the business you’re opening. If not, you could easily find yourself wasting money, spending your efforts in the wrong areas, and making mistakes that other franchisees have already made.

Before you take out a franchise business loan, you’ll want to conduct your own basic market research to make sure you know everything about the franchise, the industry, and the product or service that you’re about to sell. You’ll want to know everything about the business, including but not limited to:

  • The standardized system of management, employment, etc.
  • The products and systems that are used internally
  • The financial and accounting systems
  • The research and development process
  • The amount of access to financial assistance or financial guidance within the company
  • The sales, marketing, and advertising process

Learning the failures of others can help you avoid them. Request and read the Franchise Disclosure Document (FDD), but also visit the franchise headquarters to ask questions, see how the company is run, and learn more about what’s expected and required of you before signing any papers.

2. Trying to Do it Yourself

Thinking you can build a business without speaking with a legal expert is a mistake. You could easily miss contract details, extra expenses, and what documents need to be filed. Franchise financing can be confusing for any franchisee, but especially for those who have never owned or operated a business before.

Though it might cost extra, hiring a lawyer up front will save you a major headache — and potentially also financial disaster. A franchise lawyer not only deals with these issues every day, but will be there to support you through the whole process of buying, opening, and running a franchise — from determining the total costs and sorting through legal paperwork to helping you choose the right entity and helping you design templated training programs.

Hiring a lawyer may seem like a frivolous extra cost, but it could save you thousands (or more) in the long run. If you want to build a successful long-term business, you’ll want to consider putting a percentage of your investment toward this.

3. Spending Too Much Up Front

One of the biggest mistakes a franchisee can make is spending too much on upfront costs while not planning for future costs. You might want a quick ROI, but you can’t expect that, especially not at the beginning.

Before you approach a lender for a franchise loan, do a thorough audit of your financial history, which should include a comprehensive list of assets, debts, and current financial standings. Know what you have, what you can afford to spend early on, and what you can spend later.

Whatever you do, don’t over-invest in the beginning. Prepare for the unexpected and prepare to spend money after you get the business running. You could end up needing to put more money toward employee training, buying more inventory, buying new equipment, etc.

4. Getting the Wrong Funding

Not knowing the different franchise loan options is a major pitfall to avoid. Choosing the wrong financial option is another major pitfall to avoid. For franchise financing (which could include anything from real estate to refinancing), you’ll want to consider a loan (which will, of course, need to be repaid in the future and should therefore be included in your financial business plans). Loan decisions are made based on various factors: One is credit history, but just because you have bad credit doesn’t mean you have to get a bad loan.

You don’t have to worry about franchise financing with bad credit. These are some of the best loans for people with bad credit:

  • Franchisor financing programs: Some franchisors are willing to waive fees, work with a third-party lender to offer you a loan, and/or offer you upfront funding to jumpstart the business. For some, this is a convenient option. Before agreeing, compare the loan requirements, the expected payments, and the collateral required, and then compare it to other franchise financing options.
  • Business loans from alternative lenders: Franchise financing with bad credit is possible with a non-traditional lender. Unlike traditional lenders, an alternative lender will often approve or deny an application within 24 hours, which is important if you’re looking to make some quick decisions.
  • U.S. Small Business Administration loans: The Small Business Administration (SBA) publishes their SBA Franchise Directory, which includes a list of franchises that are covered and eligible for financial assistance. SBA loans often have low interest rates and long repayment terms, which is great for franchisees. However, the SBA will often consider credit score, collateral, and a franchisee’s capital. Ideally, the better the credit score, the higher the chances of getting approved, but if you’re looking for franchise financing with bad credit, you may still qualify for an SBA loan program.

Not listed are commercial bank loans, which often require a good credit history for approval. Traditional banks offer business loans to franchisees, but will consider your personal credit and your business plan. Depending on your credit score and the business you’re investing in, you could end up paying high interest rates with short terms, which can be problematic if the business doesn’t take off right away. As a business owner, you want to make sure you have enough room for the business to grow financially before you’re expected to make substantial repayments. Otherwise, you could end up compromising your personal finances.

If you have bad credit and have no proven knowledge or expertise in the business you’re looking to start, don’t stress. You can still make it happen with the right loan, support, and amount of funds.

5. Ignoring the Details

When it comes to investing in a franchise, not having enough capital can make or break your business before it even gets a chance to take off, but so can the details of franchising, if you neglect them.

Again, consider hiring a lawyer; lawyers specialize in details and can help you when looking at the details of the loan offerings and the franchise costs. Regardless of your franchise and the loan you choose, know that there are many details that you could overlook:

  • Ongoing royalty payments are due to the franchisor, and can be based on your weekly or monthly gross income.
  • SBA loans are typically less risky than other loan options because they are partially backed by the government. If you qualify for an SBA 7(a) loan, then you can use the money on various expenses: from machinery and furniture to working capital and debt refinancing.
  • When you open a business, you will be taxed, but if you open a franchise, you are eligible for tax credits, which can reduce how much you end up paying.
  • Some of the upfront costs due to the franchisor are non-refundable, which is why it’s so important to do your research before putting down money.
  • Extra costs include operating licenses, advertising fees, seasonal renovations, renewal costs, termination costs, and other franchise fees.

Now that you know some of the loan pitfalls to avoid when buying a franchise, start taking inventory on what you have, what you need, and how you’ll grow the business. Your local, national, or international franchise association is a great place to research next.

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