The Startup Guide to Using Business Loans for a Franchise

How to Use Business Loans for Franchise

Business loans are of various types, but not all of them can be used to purchase a franchise. Before diving into your franchise business loans, let's first detail the expenses you can expect to incur when starting a franchise. As a franchise owner, there are many costs you will be required to cover, including but not limited to:

• Franchise Fees
• Commercial Space
• Equipment/Supplies
• Raw Material
• Inventory
• Advertising and Marketing
• Utility Bills
• Insurance
• Licenses and Permits
• Employee Payroll

As you can see, just like any start-up business, there are a lot of expenses with owning and operating a franchise.

Also, each franchise will have different expenses that business loans for franchise can cover. These usually vary for each business model and product. It's important to understand the expenses and your risk appetite when selecting a franchise that works for your situation. Each franchise will provide a Franchise Disclosure Document (FDD) or something similar. The FDD is a document that a franchisor is legally required to present to the franchisee before you sign the franchise agreement. The FDD outlines the costs of owning and running a franchise. The FDD might also provide revenue projections which will help you with planning.

Once you have a clear understanding of your expenses you can then select the business loan for franchise that best works for you. Whichever financing option you choose to pursue, you will work with the lender to determine what type of credit risk you are. The lender will need to understand your business plan and creditworthiness, including your credit report and credit score, your ability to repay the loan, and your ability, skills, and experience in the business or industry to give the lender confidence that you can operate the business efficiently and professionally.

Types of Business Loans for Franchise and Franchise Management

1. Term Loans

For purchasing a franchise or to cover the franchise costs, term loans are one of the most reliable loan options available. Depending on your credit score and existing debts, you may be able to qualify for a huge loan amount and can negotiate terms like repayment tenure and interest rate. Term loans work similar to traditional bank loans and offer high flexibility to borrowers. Along with using the funds to cover franchise costs, borrowers can use the funds secured for purchasing equipment, inventory, payroll, and even commercial real-estate lease.

2. SBA 7(a) Loans

The U.S. Small Business Administration (SBA) offers the 7(a) loan. It is a popular loan program and includes financial help for businesses. This is a great choice if real estate is part of your franchise purchase. The SBA 7(a) loan can be used for short-term or long-term working capital, refinance current business debt, and purchase furniture, fixtures, and supplies.

The most money you can receive with a 7(a) loan is $5 million. There are several eligibility factors based on what the franchise does to earn revenue, its creditworthiness, and where the franchise operates.

3. SBA 504 Loans

The SBA also offers 504 loans for long-term, fixed-rate financing of up to $5 million for major fixed assets (for certain energy projects, you can receive a 504 loan for up to $5.5 million, see the SBA's website for additional details). The 504 Loan offers long-term, fixed-rate financing for major fixed assets that support business growth and create jobs.

The SBA works with Certified Development Companies (CDCs) to issue 504 loans. The CDCs are local partners who are certified and regulated by the SBA and promote economic development in their local communities.

504 loans are best used for existing buildings or land, new facilities, long-term machinery, and equipment, or the improvement or modernization of land, streets, utilities, parking lots, landscaping, and existing facilities.

Tips for using SBA Loans as Business Loans for Franchise

Use the SBA Franchise Directory to determine if the franchise you are considering opening will work with an SBA loan. The SBA franchise directly is a list of all the franchises reviewed by the SBA that are eligible for SBA financial assistance and are eligible under the SBA's affiliation rules and other eligibility criteria. There is no need to hunt around the internet to determine if the franchise you're interested in will work with SBA loans.

4. Equipment Loans

Entrepreneurs don't necessarily need to take large business loans for franchise. In fact, they can use short-term loans to cover equipment costs as well. For example, equipment loans are secured loans that franchise owners can use to purchase essential business equipment. As the invested equipment secures the entire loan amount, business assets remain protected. In various scenarios, the equipment helps boost business productivity, which in-turn helps pay back for the loan.

5. Commercial Real Estate Loans

For purchasing a commercial space, like a physical store, restaurant, barbershop, convenience store, electronics store, and more, commercial real estate loans can be useful. Again, these are secured loans that protect business assets. In case of default, the lender seizes the real estate while other assets remain protected. Various lenders may offer longer repayment terms for commercial real estate loans, simplifying down payment and reducing the impact on cash flow.

6. Business Line of Credit

For cashflow management, franchise owners can apply for a business line of credit. These act like a mix of credit card loans and term loans. Owners may get approved for a certain amount of credit and can withdraw any amount they want. Interest rate is charged only on the amount withdrawn and not on the entire credit line. With monthly repayments, the credit line gets replenished and you can borrow again as per business requirements.

7. Working Capital Loans

These generally are unsecured loans with shorter loan tenures and decent interest rates. As business loans for franchise, these provide faster access to capital and can be used for managing payroll, covering marketing costs, purchasing equipment, training new employees, and more.

8. Invoice Financing

In case of outstanding invoicing, owners can use the invoice financing option. Under this business loan option for franchise, owners can take loan against their pending invoices instead of waiting for weeks and months for the payment to arrive. Once the payment arrives, they can repay the lender. Invoice financing is usually unsecured, but the outstanding invoices and client trustworthiness often give reassurance to lenders.

Eligibility Criteria to Secure a Business Loan for Franchise

Each lender follows their own criteria. Nevertheless, loan experts recommend meeting the following to improve your chances of securing a business loan for franchise.

1. Credit Score: Having a credit score above 670, or within the ‘Good, Very Good, and Excellent' ranges as defined by Experian can help improve your chances.
   Note: Having a good credit score does not always guarantee approval. Lenders also evaluate various other parameters.

2. Income Stability: Lenders prefer disbursing loans to borrowers with stable income. In case of startups, the personal income of the franchise owner can also be considered. For income stability, lenders may ask for your bank statements, tax returns, and identity proofs.

3. Debt to Income (DTI) Ratio: The DTI ratio helps lenders evaluate if you can afford a business loan for franchise. It is a measure of your existing debts in comparison to your income. In case the DTI ratio is high, consider closing previous debts or refinancing them under single unified loan terms.

4. Business Plan: For business financing, lenders often want to see your business plans. Consider submitting detailed business model, revenue model, licenses, and even growth projection to help lenders understand how you plan to repay the debt.

5. Down Payment: For certain business loans for franchise, lenders may ask borrowers to make an upfront down payment. This down payment reduces the principal amount, interest to be paid, and overall monthly payments. In several cases, SBA lenders may also ask you to make a down payment.

6. Collateral: To reduce the risk profile for lenders, franchise owners may be required to keep certain business assets or personal assets as collateral.

7. Co-Signee or Guarantor: Having a co-signee or guarantor's name in the loan application shares your risk and improves the chances of loan approval.

Documents Required to Secure a Business Loan for Franchise

Lenders may ask you to submit the following documents:

• Business Plans
• Business Ownership Proof
• Growth Projections
• Bank Statements
• Tax Returns
• Social Security Number or Driver's License
• Debt Statements

Summing Up

Franchise brands looking to expand to newer regions are more than willing to provide franchises for entrepreneurs that qualify their requirements. However, franchise fees and working capital often remain one of the primary hurdles. Business loans for franchise help cover such costs. By exploring different loan options at multiple lenders, entrepreneurs can secure financing at competitive interest rates. They can use the amount for various purposes like staff training, payroll, marketing, and more. Also, securing a business loan does not guarantee success. Every business venture requires effort and in the franchise market, only those owners will survive who are resilient and can adapt to changing market conditions. Quick financing options can help owners meet their various goals.