Starting your own business via the franchise route can be a great long-term strategy, but some entrepreneurs may be scared off by the higher up-front costs of a franchise business. Besides the franchise fee, you’ll need to consider all of your startup costs, such as the cost of a location, inventory, staffing, etc.
While you may have the savings or investments to cover some of those costs, you might need to consider other funding sources like business lending to get you into the franchise business.
What Is a Franchise?
When you start a new franchise, you partner with an established business but still retain business ownership of the business and the majority of control about how you run the business. You pay a franchise fee, plus most likely royalties on your sales and marketing fees. In return, you get incentives like name recognition, training in running the business, and nationwide advertising associated with the brand.
Things to Consider Before Applying for Franchise Financing
Before you apply for franchise funding, you’ll want to consider where the money will come from and the best uses for the money you seek. How much can you finance yourself? Do you want other investors? Will you be paying the franchise fees with borrowed money? Do you need to acquire real estate? Do you need to build to suit the franchisor? Will you just need signage for an existing building? Can your financing all come from one source, or will you need multiple investors and/or lenders?
How Much Money You Need to Open a Franchise
The total cost of starting a franchise can vary from a few thousand dollars to the millions (consider you want to be a McDonald’s franchisee and you need to acquire land and build to suit McDonald’s expectations for a restaurant). A good rule of thumb is that a franchisee should expect to fund at least 25 percent to 35 percent of the total startup cost to be approved.
Costs of opening a franchise
As you probably guessed from earlier statements, you’ll need to consider costs far beyond the franchise fee. You’ll need a location, proper signage, staff, marketing, inventory, and possibly more.
Collateral and Personal Assets
A variety of personal assets can go into your investment in a franchise. Beyond savings, you can potentially use a 401(k) for a business investment or a home equity loan. These options might be considered a little riskier as you don’t want to lose your home or your retirement nest egg of your franchise fails.
Credit Score Needed to Open a Franchise
Generally, a credit score of 650 or higher is needed to be approved as a franchisee.
How To Qualify for Franchise Financing
As with any business venture, the better prepared you are to begin the journey as a small business owner, the better your chances of qualifying for franchise financing.
Provide Basic Personal and Business Information
Be prepared to share basic information about yourself, your family, and any business partners. Outline your experience in business and educational background. Remember, you need to convince the company about why you would be a solid franchisee.
Prepare Personal Credit History
If you have a good credit history and personal credit score, great; you’re ready to go. If you have some hiccups in your history or current issues, get them straightened out before you begin seeking franchise funding. It’s always a good idea to review your credit reports and correct any mistakes.
Prepare Financial Information
Get a financial plan together on how you would finance the startup costs and the initial period until your franchise business is generating a profit. Determine where best to spend your investment and where borrowed money would be directed.
Write A Strong Business Plan
Put together a great business plan to share with potential lenders. Your franchisor likely can help you with this. Also, visit with other franchisees in similar locations. Make sure you understand who will be your competition and how you can operate better than them.
Apply To More Than One Lender
Different lenders have different specialties, so you’ll want to consider applying to multiple lenders. You might need a real estate loan from one company, an equipment loan from another and operating capital from another.
Franchise Financing Options
Though you’ll have to come up with a certain percentage of the money for a franchise, options abound for financing the remainder of the cost.
Only about 12 percent of franchisors offer direct finance loans to their franchisees, but if you find one that does, that’s going to be your best bet as they will offer competitive rates and who better understands your business needs.
Commercial Bank Loans
Commercial bank loans will offer better rates and long-term payoff schedules, but your personal financial situation will need to be strong to qualify.
401(k) Business Financing
If you have a 401(k) from a previous employer, you could finance your franchise through a Rollover as Business Startup (ROBS). To do this, you need to form a corporation and rollover your 401(k) into the new corporation’s 401(k). That entity, then buys stock in your franchise, thereby loaning the money without tax or penalty, as you would encounter if you tried to just take money out of your 401(k). The IRS classifies ROBS as “questionable,” so you’ll want to have this set up by a qualified tax attorney to ensure it’s done properly.
SBA Loans for Franchisees
SBA loans are a great choice for franchise loans because of their long terms and relatively low-interest rates. The SBA Franchise Directory includes all franchises that have been approved by SBA for potential startup loans.
SBA 504/CDC Loans
504 loans are targeted toward real estate, property, and equipment costs and are granted through community development corporations designed to spur local economic growth.
SBA 7(a) Loans
7(a) loans are granted through commercial lenders but with a certain percentage guaranteed by SBA, making them less risky for the lender. These can be short-term or long-term loans to cover a variety of startup costs.
Alternative lenders have sprung up during the past decade or so to address the financing needs of small businesses. These loans come at a slightly higher cost because the lenders are willing to take a greater risk, but they are much easier for small businesses to obtain, and often they can be funded the next business day. Alternative lenders also offer a variety of types of loans designed especially for small businesses, such as merchant cash advances, invoice loans, and equipment loans. Many, such as First Down Funding, also are authorized for SBA loans.
Many crowdfunding websites offer franchise businesses the opportunity to raise funds from individuals who are willing to support a new business owner.
Friends and Family Loan
Friends and family are always a good, low-cost source of funding for franchisees, though you want to ensure the transaction doesn’t damage the relationship.
How to Improve Your Chances of Being Approved for Franchise Financing
Three key items will help you improve your chances of being approved for franchise financing:
- Have your personal finances in order. This might mean working to drive your credit score up or save more money before taking the plunge.
- Write a great business plan. The more you can convince lenders you understand your business and how you will make it grow, the better your chances.
- Be creative in seeking financing. If you’re going through traditional channels such as a commercial lender or SBA to get funding for your location, maybe you can get an equipment loan right away from an alternative lender to get started working from your garage or a rented location.
Look Into Alternative Financing
Alternative financing will get your franchise up and running much quicker than traditional loans. Though they might come at a higher cost, the value of getting your franchise up and running sooner will benefit your business in the long run. Banks.com has found First Down Funding to offer a wide variety of financing options for new franchisees.
First Down Funding: Small Business Alternative Lender
First Down Funding offers small businesses the opportunity to acquire business loans of $2,000 to $300,000 with approval in minutes and funds available within 48 hours.
FAQs About Franchise Financing
Yes, you can choose from a variety of funding sources to get small business loans to start a franchise.
Depending upon the lender, you could borrow a few thousand dollars up to $5 million with an SBA loan.
By exploring the gamut of financing sources, the vast majority of applicants can secure franchise financing.
The total cost of opening a franchise normally runs between $75,000 and $500,000, with half under $250,000. Some franchise fees run are only in the hundreds of dollars.
The best way to finance your first franchise would be out of your pocket, but since that’s not feasible for most entrepreneurs, exploring the variety of finance options always pays off.