Franchise Financing: Loans for Funding Your Business
Options for franchise financing include SBA loans, commercial bank loans, and loans from alternative lenders. Other options include getting a loan from friends or family or borrowing against property you own.
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For small business owners, opening a franchise business can be a great way to get a new company off the ground — since the hard work of developing a brand and a business model has been done. However, there are considerable costs associated with franchise ownership that you need to be aware of and find a way to finance. This includes upfront costs as well as ongoing expenditures.
Coming up with the upfront franchise fee can be a major challenge, but don’t let the big price tag put you off of your dream to own and operate a franchise business. There are many types of small business loans you can use for franchise franchising, as this guide will explain.
On this page:
- Costs and Requirements for Opening a Franchise
- Different Methods for Franchise Financing
- What You Need to Get Franchise Financing
Costs and Requirements for Opening a Franchise
The specific fees and other costs you’ll need to pay to become a franchise owner will vary depending upon the business you choose to open. But you should understand the basic expenses you’ll incur when opening a franchise business.
As the Federal Trade Commission explains, you will need to pay initial franchise fees, as well as continuing royalty payments. With some franchises, you’re also required to contribute to an advertising fund — and some of the money from this fund may go towards national advertising.
The initial franchise fees will vary depending upon the specific franchise you buy. The FTC indicates that these fees could range from several thousand dollars to several hundred thousand, while the Small Business Administration indicates that typical franchise fees are between $20,000 and $50,000 unless you’re purchasing a master franchise.
Master franchises usually cost $100,000 or more and involve buying the rights to sell other franchises within a specific geographic area.
Your costs could be higher depending on whether you’re buying or renting real estate to open your new business.
The monthly marketing or advertising fees are typically based on a percentage of your revenue. For example, the SBA indicates that the fee for advertising could be around two percent of your monthly revenue. Royalties are also collected monthly and are charged based as a percentage of revenue, along with the marketing fee. These costs could be between 4 percent of monthly revenue and 12 percent of monthly revenue.
To make sure that would-be franchise owners can afford the payments that will need to be made, applicants for a franchise are expected to provide documentation to show they meet the company’s net worth requirements. You won’t necessarily have to pay all the start-up costs out of the assets you have, but you’ll need to have proof of your net worth and ability to afford upfront and ongoing expenses.
Different Methods for Franchise Financing
Coming up with thousands of dollars to start a franchise is undeniably challenging, but you have a number of possible franchise financing sources, including the following:
Many major franchises provide financing options to those who want to become owners. For example, the UPS Store offers franchise financing to those who want to open stores of their own. This is offered through a partnership with Guidant Financial.
If you choose to finance through your franchisor, the process will generally be simplified because the lender understands the business model as well as the amounts needed. Franchisors who offer their own financing also typically provide funding not just to pay initial franchise fees but also to pay other upfront costs you’ll incur when you get your franchise up and running.
Terms and conditions, including the maximum you can borrow and the rates you’ll pay, will vary depending upon the specific franchise financing program you are interested in. You should ask the company offering the franchise you are interested in purchasing if they have financing partners you could work with to secure funding.
Commercial Bank Loans
Commercial bank loans are typically loans with a fixed term obtained from a bank or sometimes a credit union. After you submit your loan application, lenders will review your business plan and credit history to determine if you qualify for funding — and you’ll need to provide proof that you have a solid plan to pay back what you borrow by making your business profitable.
In most cases, with commercial bank loans, your personal credit is considered, not just the credit history of any business you may operate. Most commercial bank loans are unsecured, which means there is no collateral — but because you’re personally guaranteeing the loan, it’s possible the lender could try to collect from you personally if the business you start can’t pay back the loan. This means you’re technically putting your personal wealth at risk.
Interest rates and terms, as well as maximum loan limits, vary by bank as well as based on your credit and the loan amount. Generally, the better your credit and the shorter your loan term, the lower the rate will be.
SBA loans aren’t actually made by the Small Business Administration. However, the SBA guarantees loans made by other lenders. By guaranteeing or insuring loans, the SBA makes it less risky for lenders to provide funding. This means more lenders are willing to lend and are open to giving money to people who aren’t quite as well qualified.
There are actually a few types of SBA loans, including 7(a) loans, 504 loans, and microloans.
- Microloans are available for up to $50,000. They can only be used for specific expenditures, such as buying inventory or to provide working capital.
- 504 loans are intended to buy fixed assets, such as purchasing equipment, fixing up a building, or buying land.
- 7(a) loans are the most common SBA loans. You can borrow as much as $5 million and can choose from other fixed rate or variable rate loans.
SBA loans have many benefits, including lower rates than loans not guaranteed by the SBA — in most cases. It’s still important to shop around and understand qualifying requirements for SBA loans, as you will need to invest your own money in your business and exhaust other borrowing options before you become eligible for an SBA loan.
SmartBiz can connect those seeking franchise financing to lenders offering SBA loans of up to $350,000 for loan terms up to ten years, so this can be a good place to start. But you should be aware that it can take a long time to get funding from an SBA loan — usually around two months.
Alternative lenders generally have more lax financing requirements than loans guaranteed by the SBA or made by a major commercial bank. Alternative lenders are often found online and can provide loans for different franchise costs such as equipment financing. They can also provide a term loan that is repaid on a fixed schedule, similar to a loan from a commercial bank.
While alternative lenders may be more willing to give you a loan, you’ll still need to meet basic credit score and income requirements to get approved. The interest rate and terms of your loan will vary based on the specifics of your situation; however, typically interest rates are below the rates offered by traditional lenders. However, repayment timelines may be shorter, which means you’d need to establish cash flow quickly and make higher monthly payments to get your loan paid off on time and in full before payment is due.
In addition to each of these options, you also have a few other choices for franchise loans, including:
- Taking a loan from friends and family
- Borrowing against the equity in your home using a home equity loan or line of credit: You could tap into the equity in your home, provided you owe less than it’s worth
- 401(k) business funding: In some cases, you can use money from 401(k) funds to invest in a franchise without triggering early withdrawal penalties if you haven’t yet reached age 55 or 59 ½
There are risks associated with these options, though. For example, if you borrow against your home equity, you put your house at risk and might become trapped in your home since you cannot sell it without a short sale or without coming up with cash if you owe more than it’s worth. Or, if you borrow against your 401(k) and your business isn’t successful, you may not have enough funds for retirement. Borrowing from your family could ruin relationships if you can’t pay the money back.
Think carefully about the pros and cons of each of the franchise funding options so you can find the right one for you.
What You Need to Get Franchise Financing
To secure franchise financing, typically you’ll need:
- Good credit, including personal credit and business credit if applicable
- A personal financial statement: This should show your net worth and should provide details on assets and current liabilities.
- A business plan: You’ll need to show how you plan to make the franchise profitable.
- Bank statements: This will help lenders to see proof of assets and to see your inflows and outflows.
- Proof of income: Lenders want to know you have enough annual revenue coming in to pay your franchise loan.
Bottom line: Franchise Financing Should Be Available for Qualified Buyers
To be eligible to buy a franchise, you’re going to need to prove you have a good credit rating and that your net worth is reasonably high. If you meet the criteria to secure a franchise, you will likely also meet the criteria to secure a loan.
So, shop around to find a lender that’s right for you and look for the most affordable franchise loan so you can keep as much of your profit as possible in your pocket.
Author: Christy Rakoczy