Financing a franchise is a significant investment, but potential franchisees who are short on capital shouldn’t get discouraged by the high price tag. With a little strategy, it’s possible to find the right mix of funds that will turn the dream of franchise ownership into reality.
What is franchise financing?
Franchise financing is how franchisees pay for franchise fees and other business start-up expenses. Most owners cannot afford to cover these out-of-pocket costs and need to apply for a loan. Still, lenders generally require some personal funds upfront and may ask for as much as 10 to 30% of the total investment in cash.
Options for funding a franchise
Franchisees usually have more than one way to finance the purchase of a franchise and may even be able to combine funds from different sources to achieve the necessary capital. Options include:
- Franchisor financing
In some cases, franchisors may offer financing directly through the parent company, but more commonly, they partner with preferred lenders who administer the loans to their franchisees.
- Commercial bank loans
Franchisees can apply for a commercial loan with a bank of their choice. Approval usually requires a good credit rating and a detailed business plan.
- Small Business Association (SBA) loans
Because the federal government backs a portion of SBA loans, they generally have more favorable interest rates and repayment terms than commercial banks loans. Type 7(a) loans are ideal for new franchises, compared to type 504 loans, which have more limitations.
- Alternative lenders
If a franchisee is unable to secure a commercial bank loan or an SBA loan, alternative lenders may be an option. Their approval process is faster and less stringent than that of traditional lenders, but the interest rates are generally higher and the repayment periods are shorter.
- Personal assets
Savings accounts, severance packages from previous employers and home equity and retirement savings plans are sometimes used to help finance a franchise. Leveraging personal assets, however, can jeopardize financial security in the future.
- Rollovers as business startup (ROBS)
ROBS is a method of withdrawing money from a 401(k) or other retirement savings accounts to fund a new business without incurring penalties. Rollovers are risky if not done correctly and although legal, the IRS considers them questionable.
Lacking few other options, entrepreneurs may attempt to raise money via online forums. Investors typically receive early access to products, shares in the company or other perks in exchange for their investment.
- Friends and family
Borrowing from friends and family is an attractive choice for those who have poor credit ratings or can’t afford to pay interest. This type of funding can negatively impact personal relationships, though, especially if the venture isn’t successful.
Who qualifies for franchise financing?
Entrepreneurs who qualify for franchise financing generally have positive net worth, or more assets than debts. Many franchisors will ask to see a personal net worth statement before seriously considering any investor. They also may require the franchisee to have a minimum amount of liquid assets at their disposal to cover start-up costs, living expenses and other financial obligations until the business becomes profitable.
How to obtain a franchise loan
Whether it’s a loan directly from the franchisor, the SBA or some other lender, franchisees who obtain approval generally:
- Talk to the franchisor
Franchisors may offer in-house financing or have an approved list of lenders who are inclined to work with franchisees.
- Verify SBA eligibility
Franchises listed in the SBA Franchise Directory have more lending opportunities than those that don’t meet SBA criteria.
- Determine collateral
Investors must guarantee their loan with valuable assets, such as cash, property, stocks, vehicles, etc. The more collateral, the better the chance of approval.
- Check credit history
Running a credit report before the lender does gives the franchisee a chance to correct any inaccuracies.
- Secure the down payment
Franchise lenders, on average, expect investors to put 20% down.
- Create a business plan
Alternative lenders may only ask for a one-page summary, but banks typically require a detailed plan with revenue and expense estimates.
- Provide information about the franchise
Financial institutions tend to be more inclined to work with franchises that are well-known and have a history of success than those that do not.
- Apply with multiple lenders
In addition to increasing the likelihood of securing at least one approval, applying with several different lenders allows investors to compare rates and terms and get the best deal.
Frequently asked questions about franchise financing
How can I get a franchise with no money?
All franchises, whether they be high or low-end options, require money on the part of the investor. Those with limited funds might need to wait and improve their financial situation before embarking on a new business venture.
Do banks give loans franchises?
Franchisees who have good credit history and a business plan may be eligible for a commercial loan with a bank. It sometimes helps to apply with financial institutions that have experience working specifically with franchises and not just small businesses.
How much can I borrow for a franchise?
The Small Business Association (SBA) allows investors to borrow up to $5 million for the purpose of opening a franchise or small business. Other lenders may have different limits, depending upon the individual’s credit history and business plan.
This guide is intended to be used as a starting point in analyzing franchise financing and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.