Best Financing Options for Starting a Franchise
January 17, 2023 | Last Updated on: February 6, 2023
January 17, 2023 | Last Updated on: February 6, 2023
Owning a franchise combines the flexibility and independence of being a small business owner with the backing, support, and infrastructure of a large corporation. A franchise can be an excellent solution for anyone interested in becoming an entrepreneur but is not ready to go it alone.
Paying for a franchise can be expensive. However, people interested in purchasing one who are short on working capital shouldn’t be discouraged by the high price tag. With a bit of research and hard work, it’s possible to get financing to turn the dream of owning a franchise into reality.
Franchise financing allows first-time or serial franchisees, whether investing in a new or existing franchise, to pay upfront franchise fees and other business startup costs. The cost of opening a franchise is significant. Most people cannot afford to cover them out-of-pocket, so they seek financing. In most cases, lenders require some personal funds to be put up before they provide financing, usually 10 to 30 percent of the total investment.
Franchisees have many funding options available to them. They may access one or several of these financing programs to pay for their new business. Here are some of the most common options.
Many franchisors offer direct financing to franchisees or through preferred lenders who administer the loans. It’s a common and beneficial way to finance a franchise. Some franchises that offer financing include Gold’s Gym, UPS Store, and Meineke.
One benefit of franchisor financing is that all your cash and business needs can come from a single source. Many programs offer loans not only to cover franchise fees but also to buy equipment, real estate, and the other things you need to operate the business.
Each franchisor financing agreement differs. Agreements may include deferred payments during the business startup phase or they structure repayments on a sliding scale.
Even if your franchise company offers financing, it’s worth doing your homework and shopping around. This type of funding may not always come with the lowest interest rates or most favorable terms. Always have an experienced business attorney or accountant review the terms of both your franchise agreement and loan paperwork, so you understand everything before you sign.
Franchisees can apply for a commercial loan from a bank or other traditional financial institution. It comes in the form of a term loan, which provides a lump sum of cash that you pay back with interest monthly over time. It’s what most people think of when it comes to loan financing. It is similar to a student loan or home mortgage.
The franchisee must have a good credit history, an overall positive financial situation, significant business experience, and submit a detailed business plan to qualify for a bank loan. The lender will use this information to assess creditworthiness. During this process, the bank determines whether or not you can reasonably afford to repay the loan money and how likely they are to get it back.
Bottom line: The better your financial history and the higher your credit score, the lower the interest rate and more favorable loan terms you can expect from your bank.
Of all the loan options available, one of the most attractive options for franchisees is SBA loans, which are partially backed by the U.S. Small Business Administration and funded by intermediaries affiliated with the SBA.
SBA loans are similar to traditional term loans from a bank or alternative lender. However, the SBA reduces the risk to lenders by guaranteeing a portion of the loan amount. The guarantee incentivizes lenders to offer more loans to small business owners with lower interest rates and longer repayment terms than they usually would.
Be aware that the qualification standards for SBA loans can be stringent. The application process is cumbersome and can take many months to complete. Because of the time it takes to be approved for an SBA loan, it’s wise to consider your chances of being approved before you apply. You could lose out on your opportunity to purchase a franchise if you go through the several-month application cycle only to find out you don’t qualify.
Also, carefully consider which SNA loans are suitable for your situation. The SBA 7(a) loan program is ideal for new franchises, compared to SBA 504 loans, which have significant limitations.
If you need money to purchase and fund other aspects of your franchise quickly or want to secure additional capital to supplement a traditional bank or SBA loan, consider applying for franchise lending through an online or alternative lender.
Typically, online lenders have simpler application processes and less-stringent requirements than traditional financing options. Applications can be approved and funding completed in one or two business days.
Be aware that the less stringent approval requirements, convenience, and fast access to cash could end up costing you. Alternative loan products tend to come with higher interest rates and fees and shorter repayment terms than those from traditional counterparts.
Alternative lenders offer a wide range of lending options, including short-term loans, long-term loans, equipment financing, business lines of credit, and more.
Of course, you can fund a part of your new franchise with your own money from savings accounts, severance packages, home equity, and retirement plans. However, using personal assets can jeopardize your future financial security.
ROBS allows you to withdraw money from a 401(k) or another retirement account to fund a franchise or other new business without penalties. Rollovers can be risky if not handled correctly, and you could get into IRS trouble if you make a mistake. Get help from an experienced financial professional if you pursue a ROBS.
If franchise financing isn’t available from your franchise company, bank, credit union, SBA lender, or alternative loan provider, you may want to consider crowdfunding. Crowdfunding allows you to solicit financing from others in return for a share in your business or another benefit.
You can set up and promote your own crowdfunding page or work through an organization that provides crowdfunding for small businesses and franchises. Certain websites also crowdfund for companies in specific industries.
Crowdfunding is a possible option if you have a bad credit score and don’t qualify for other business financing options. Just check with your franchise company to ensure it allows crowdfunding financing.
Borrowing from friends and family can be an attractive choice for future franchisees with poor credit ratings or who can’t afford to pay interest. However, this form of financing can harm personal relationships if your franchise fails and you can’t pay the money back.
If you decide to take a loan from a family member or friend, work with your lawyer to write up a legal agreement that includes repayment terms and expectations. If everyone understands the contract before signing, it’s less likely issues will come up later on.
Future franchisees who qualify for franchise financing generally have a relatively high net worth. Many franchisors require a personal net worth statement before allowing anyone to open or purchase a franchise. They usually need franchisees to have a minimum amount of liquid assets to ensure they can cover start-up costs and other financial obligations until the business becomes profitable.
Because most reputable franchise companies have such stringent personal financial requirements, it makes it more likely franchisees will be approved for financing.
After you determine the type of loan that’s right for you, here are the steps to take to get approved.
Becoming a franchise owner is a great way to achieve your entrepreneurial ambitions. You get to be a business owner while enjoying the safety net of a large corporation backing you. While the price of entry for most franchises is high, securing the right franchise financing could make your dream a reality.