The Best Financing for Buying a Restaurant Franchise
July 27, 2022 | Last Updated on: February 2, 2023
July 27, 2022 | Last Updated on: February 2, 2023
Do you want to open a restaurant but avoid the risk and stress of developing a concept and launching it on your own?
Opening a franchise restaurant or purchasing an existing franchise could be the perfect business model for you.
It offers you the chance to be an entrepreneur and restauranteur with the security of being backed by an established corporation and a proven restaurant concept.
Investing in a restaurant franchise, especially a well-known national chain, can be costly. Most franchisees have to depend on some form of business financing to get established. This article will explain the franchise financing options available to entrepreneurs interested in opening restaurant franchises and the pros and cons of each.
The first place to look for franchise financing is through the franchisor itself. Many, including Marco Pizza, A&W, and DQ Grill & Chill, offer financing directly or through business loan companies approved by them. Not all restaurant franchise companies offer loans, and some only provide loans for limited uses like upfront startup costs, equipment financing, working capital, or real estate development. (Most won’t cover — or allow funding — for a franchise down payment or franchise fees. You’ll have to cover these with your retirement funds, investments, or other savings.) Still, it’s worth checking to see if your franchisor offers funding before looking at other options.
Franchisor financing agreements differ. Some can take on as much as 75 percent of the debt burden from a new franchise owner. Others finance a much smaller percentage. Some agreements may allow deferred or reduced payments while the franchise restaurant is in start-up mode. Always have your business attorney or accountant review the terms of both your franchise agreement and financing documents. Make sure you understand — and are comfortable with — all aspects of the franchise disclosure document and any loan paperwork. If not, ask questions until you feel confident about accepting both.
Pro: Franchise financing programs are typically the easiest way to get funding for your new business.
Con: Not all franchise companies offer financing, and if they do, the money might not be able to be used for all expenses. Also, it’s a good idea to shop around to ensure you get a loan with a low-interest rate and fair repayment terms.
Another common option for franchise restaurant financing is a term loan from a traditional financial institution. A term loan is what most people think of when it comes to loan financing, especially if you’ve ever taken out a mortgage or student loan.
Funds from this type of small business loan can be used for almost any purpose. If approved, you’ll receive a lump sum of cash to use as capital for your franchise startup, then pay back the loan with interest on a set payment schedule.
Traditional bank loans are an excellent way to secure capital because they come with relatively low-interest rates and reasonable repayment terms compared to other types of loans from different providers. However, to qualify for a large amount of money, you will need a nearly perfect credit score and a strong business track record, which is also likely a requirement for qualifying to own a franchise, especially a competitive national one.
You’ll also have to undergo an extensive application process, including providing bank statements, financial statements, tax returns, a complete business plan, and more. The bank will check your personal credit score and business credit history as part of the loan underwriting process. Many of these things, along with your net worth and other personal financial information, will also be required as part of your franchise application process, so you probably have to prepare and gather these documents anyway.
The lender uses all this information to assess your creditworthiness. In short, the bank is trying to figure out whether you can reasonably afford to repay the loan you’re requesting and how likely they are to get their money back with interest. The stronger your business and financial history and credit score, the more likely your application will be approved and the better the terms and interest rate you’ll receive.
One other important thing to be aware of is that a traditional bank will likely require you to put up business collateral and a personal guarantee to back your loan. If you put up collateral or make a guarantee, the bank can take your business and personal assets if you miss making your monthly loan payments.
Pro: Loans from traditional lenders come with attractive interest rates and loan terms.
Con: The application process for bank loans is challenging and time-consuming, and only the most experienced business people with top credit scores qualify.
SBA loans, especially the popular SBA 7(a) loan, are among the most appealing financing options for aspiring franchisees. The loans are backed up to a certain percentage by the Small Business Administration. The application and funding process comes from intermediary lenders approved by the agency.
These loans are similar to traditional term loans from a bank or alternative lender. The difference is that the SBA reduces the risk to lenders by guaranteeing a percentage of the total loan amount. This incentivizes lenders to provide more loans with lower interest rates and longer repayment terms to solid small business owners than they otherwise would.
The qualification standards for SBA loans are stringent, and applications take a long time to process, typically weeks or months. You must have very good credit to qualify for an SBA loan. Still, if time is on your side and you have solid credit and business records, an SBA loan could be a great way to fund your restaurant franchise. If not, it could just be a waste of your time.
Pro: The guarantees that back a percentage of SBA loans result in lower interest rates and better terms than most other loan types.
Con: The SBA loan application and underwriting process is a long one, and the requirements to get approved for the loans are very stringent.
If you need cash to fund your restaurant franchise quickly or want to secure additional capital to supplement a traditional term or SBA loan, you may want to apply for franchise funding through an alternative lender. From short-term loans to equipment and real estate loans loan products. Business lines of credit and other funding options from online lenders can help keep your franchise restaurant funded and running over time. Business lines of credit are similar to home equity lines but provide money you can use to help with business cash flow issues.
The difference between alternative online lenders and traditional ones is that they use an expedited online application process and have less strict approval standards. That means you are more likely to get approved quickly. In many cases, you could get your loan money deposited into your bank account in as little as one business day.
Alternative loans tend to come with higher interest rates and offer shorter repayment terms and lower loan amounts than ones from traditional banks. However, it may be worth it if you need to supplement your current financing, aren’t able to qualify for a bank or SBA loan or need cash fast to fund some aspect of your franchise restaurant business. Loans from alternative lenders can also be acquired must faster!
If financing isn’t available through your franchisor or you can’t get approved for bank, SBA, or alternative loans, you may need to get creative. One way to do this is to consider crowdfunding.
You could set up and promote your own crowdfunding page. Or you might partner with an organization that crowdfunds for franchises and other businesses. Some websites crowdfund specific firms and industries, then lend money to small business owners who need financing.
Pro: Crowdfunding can be a sound financing option if you have credit and financial history issues and aren’t satisfied with the financing you’re able to qualify for.
Con: It could be challenging to get as much financing as you need through crowdfunding. Franchise restaurants are expensive to operate.
One of the most common ways to finance a franchise restaurant, especially lesser-known local chains, is by borrowing from family.
Whether you get a loan, ask for a gift, or bring someone on as your business partner, financing from friends and family members typically comes at a fair cost and with reasonable terms. However, many of these situations result in lost friendships and family disagreements if the franchise restaurant owner can’t pay the money back.
If you decide to accept cash from friends or family, write up contracts that include repayment terms and expectations on both sides. If everyone understands the agreement before signing, disagreements will be less likely in the future.
Pro: Getting financing from family members and friends is relatively easy and inexpensive.
Con: You could destroy essential relationships in your life if you fail to repay a loan.
Now that you know the pros and cons of different franchise loan types, you can get the financing you need to open the restaurant of your dreams.