Franchise Funding
What Entrepreneurs Need to Know.
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Buying a franchise can give businesses a headstart, when compared to starting a business from scratch. However, finding the capital for it can be difficult. The total cost typically includes initial fees, startup expenses, equipment, and working capital. Since most people may not have hefty cash ready, they need loans or other ways to finance the purchase. Thus, this page covers how franchise funding works, the different choices available, and what a business should know before starting. Further, readers can know more about tips to improve loan approval chances, mistakes to avoid and who may qualify for it.
Difference Between Franchising and Buying a Business
Before deciding which option is the best fit, understanding the difference between franchising and buying an existing business is important. The main difference lies in the degree of control one has over the business. A franchise is a business model where the "franchisor" sells the rights to their business logo, name, and model to an independent entrepreneur, also known as the "franchisee". The franchisee gets benefits, such as brand recognition, promotions, and marketing. But it also means, that they have to follow rules set by the parent brand, pertaining to how to run the franchise. Typically, restaurants, quick service restaurants (QSRs) and hotels are franchised.
What is Franchise Funding?
Franchise funding is how franchisees pay for fees and other expenses related to the business; franchise in this context. Most owners may not be able to afford these out-of-pocket costs initially and that's when they need to apply for franchise funding. However, lenders generally require some personal funds upfront, and this may vary, as per the loan terms and lender type.
Loan to Buy a Franchise: Available Options
Franchise funding in the USA is available through various options including government-backed SBA loans, commercial bank loans, franchisor financing, and alternative lenders. Franchisees can also use personal funds, such as home equity lines of credit (HELOC) or Rollovers for Business Startups (ROBS). The best option depends on the applicant's financial situation, the specific franchise, and the amount of funding needed for startup costs like franchise fees, real estate, and equipment.
Government and bank loans
- SBA Loans: These are a popular choice for franchising. The Small Business Administration (SBA) guarantees a portion of the loan, making it less risky for lenders, resulting in better terms for borrowers. Gov-backed lenders (banks or other financial institutions) provide the funds, not the SBA itself. The down payment required for a small business loan is not fixed and differs significantly by loan program, lender, and the nature of the business.
- Commercial Bank Loans: Franchisees can apply directly for a commercial loan from a bank. Approval usually requires a strong credit rating and a solid business plan, however, it may depend on various factors set by the lender.
Franchisor options
- Franchisor Financing: Some franchisors may offer in-house financing or partner with specific lenders to help their franchisees get loans. Details can be found in Item 10 of the Franchise Disclosure Document (FDD).
- Franchise-specific Lenders: There are online lenders, that have expertise in franchise financing and may have relationships with specific franchisors.
Personal and alternative funding
- Home Equity Lines of Credit (HELOC): A revolving credit line secured by the equity in homes, HELOC gives funds to borrowers as needed to a set limit. It functions similarly to a credit card but with the applicant's home as collateral, resulting in lower interest rates. A key benefit is flexibility, as the borrower pays interest only on the amount drawn, and it can be used for major purchases, renovations, or emergencies. However, failure to repay could lead to foreclosure.
- Rollovers for Business Startups (ROBS): This financing solution allows individuals to use their existing retirement funds, such as a 401(k) or IRA, to finance a new venture. This is achieved by rolling the money into a new 401(k) plan for the business, which then allows the applicant to use those funds for business start-up costs, without a loan or paying penalties. The funds are not considered borrowed but rather an investment in the new company.
- Alternative Lenders: These lenders are not related to traditional banks. If a funding application has been rejected or if there is a need for quicker response time, alternative lenders may be an ideal option. They may have higher interest rates but less stringent requirements. Online lenders specializing in franchise financing are also an option.
Key considerations
- Down Payment: Most lenders will require you to have some of your own cash on hand.
- Credit Score and Financial Health: Your personal and business financial history will significantly impact your ability to secure financing.
- Franchise Strength: The strength of the franchise brand you choose can influence the availability and terms of loans.
- Business Plan: A detailed business plan is crucial, especially when applying for commercial loans.
- Loan Requirements: Be aware of recent changes to SBA loan guidelines, such as the requirement for additional collateral and life insurance on certain loans.
Franchise Loans: Who Qualifies?
For applicants to qualify for franchise funding in the U.S., they must generally show strong financial health, relevant experience, and a solid business plan. Key qualifiers for franchise funding include a above-average to good credit score, a certain amount of personal capital for a downpayment (if and when required) and franchisor approval. Here's a list of key qualification criteria checked out by lenders and franchisors, to get franchise funding:
Creditworthiness
A healthy personal credit score is crucial, as it indicates a steady history of managing financial responsibilities. A good credit score may lead to better loan terms.
Down Payment
Most traditional lenders and SBA loans require a down payment, which must come from personal equity or other non-financed sources. Lenders also commonly check liquid assets of a business (cash, stocks, etc.) and overall net worth. This is to ensure that the borrower can cover startup costs and daily expenses, until the business starts churning out profits
Business Plan
A detailed business plan is needed to apply for any loan. This draft should include market analysis, expected revenues and profit levels, how the funds will be used and the team behind it.
Experience
Lenders and franchisors typically prefer candidates with prior management experience or transferable skills, relevant to running the franchise.
Franchisor Approval
The franchisee must meet the specific net worth, liquidity, and operational conditions set by the franchisor. The latter needs to approve the applicant as a franchisee, before any loan can be sealed.
Legal Status
Applicants must meet the minimum legal age and residency/citizenship criteria, as per U.S. lending laws and franchise agreement norms.
Collateral
Although not always needed, pledging personal or business assets as collateral may offer lenders with more security. This is especially true for riskier loans, to improve loan approval chances.
Business Loan for Franchise: Tips to Improve Approval Chances
Regardless of the franchise funding type, there is a list of common tips to improve loan approval chances. The steps include to improve loan chances for franchise funding are:
01 Review Personal and Business Credit Scores
A solid credit history for both is important for approval.02 Gather Financial Documents
Have 2-3 years of tax returns, bank statements, and audited financial statements ready..
03 Develop a Detailed Business Plan
Outline business goals, market analysis, and financial forecasts. For acquisition funding, this plan must specifically mention the post-acquisition merger and growth strategy.
04 Conduct Strict Due Diligence
For acquisition funding, this is a non-negotiable step to assess the target company's true financial health and legal standing.
05 Organize Legal Documents
Prepare business registration certificates, articles of association, and any relevant contracts.
06 Review Collateral
Determine which business or personal assets may be available to secure the loan, if necessary.
07 Research Lenders
Look for lenders (banks, SBA, private equity) who have experience with your specific type of financing need..
Franchise Funding: Mistakes to Avoid
To avoid mistakes when applying for general franchise funding or a small business loan for franchise, lenders must primarily focus on thorough research and financial planning. Usually, the key errors include neglecting the legal franchise agreement, poor location selection, failing to use franchisor support, and expanding too quickly. Also, the franchisees need to be aware of unrealistic franchisor expectations and shouldn't underestimate the initial and daily costs involved. Here's a list of key steps to undertake, to avoid common mistakes when applying for franchise funding:
Conduct thorough research
Do not rush into buying a franchise without understanding the business model, market conditions, and the parent brand's specific requirements.
Perform detailed financial planning
Underestimating or overestimating total costs, including the initial fee, ongoing royalties, and working capital, is a major risk.
Hire a lawyer
Hiring an attorney to review the franchise agreement and other legal documents helps ease out legalities. The Federal Trade Commission (FTC) Franchise Rule requires franchisors to provide a Franchise Disclosure Document (FDD).
Understand the franchise agreement
This is a legally binding document. Be sure to understand all the terms. A lawyer can help identify potential issues.
Review the franchisor's support
Choose a franchisor that offers enough training and ongoing support, to navigate the franchise acquisition.
Select the right location
Research locations; consider traffic bottlenecks, competition in the area, and market demands, rather than just choosing a high-footfall area.
Follow the rules
Typically, franchisors have their own set of rules and adhering to them gives way to brand consistency and product quality.
Manage growth carefully
Franchisees should avoid expanding too quickly before generating the necessary capital and honing management ability.
Beware of unrealistic expectations
Being mindful that the franchisee does not have absolute freedom and is required to follow the franchisor's rules is important.
Franchise Funding: Choose Smart Funding, Master the Business
For business owners or rather franchisees making up their minds to launch a new franchise, getting the right franchise funding is the ultimate path to success. This guide has detailed the franchise funding options that exist, from traditional franchise loan programs like the SBA to using retirement savings via the ROBS program. By carefully planning for upfront costs, choosing smart funding ways, and mastering the complex funding process, small business owners and potential franchisees can successfully take the first step towards their dream. The readiness of franchise owners to get this crucial business financing, defines the successful start of their new venture.
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Frequently Asked Questions on Franchise Loans
1. How much can franchisees borrow under franchise funding?
Lenders may have different terms and conditions, depending upon the applicant's credit history, business plan and revenue forecast.
2. What are the different ways to fund a franchise?
There are several ways to get franchise funding. This majorly includes commercial bank loans, SBA loan for franchise and alternative lenders, among other options. Eligibility depends on the loan type and lender's requirements.
3. Is it possible to get franchise funding with no capital?
Most franchises require some amount of personal financial contributions. Nonetheless, applicants may explore funding options that minimize or eliminate upfront personal capital. Choosing franchisor financing, government-backed sba loans, or securing investors/partners, is one to way to go about it.
4. What is the total costs involved in buying a franchise?
The total investment goes beyond the initial franchise fee, covering costs like real estate build-out, equipment, and starting inventory. Franchisees must also create a budget for working capital, which is the cash needed to cover operational costs until the business starts minting profits. Additionally, franchise funding borrowers need to pay a certain fee to the franchisor, typically calculated as monthly royalty fees based on overall sales.
5. What are the common ways to purchase a franchise?
A common option when it comes to franchise funding, is the SBA 7(a) Loan. It is a government-backed loan offering favorable rates and long repayment terms for qualified applicants. Another common method is Rollovers as Business Start-Ups (ROBS), which allows applicants to use retirement funds tax-free and penalty-free, for the purpose of purchase. Traditional bank loans and financing programs offered directly by the franchisor are also widely used options.