Franchise Financing: How to Find Franchise Loans

Starting a franchise is a great opportunity for people who want their own business. You get the benefit of an established brand with a record of success. So you aren’t starting from scratch trying to gain brand awareness. The expertise and tools offered by a franchise can be especially helpful to someone who is new to the business world.

In exchange for that knowledge and expertise, however, the business owner often gives up a lot of the flexibility and control over the business. In addition, franchise start-up costs, franchising fees, equipment, and inventory costs can add up quickly.

Expenses of Starting a Franchise

Opening a franchise requires additional expenses beyond the normal expenses associated with operating a business. Franchise fees vary with each company, but they are usually tens of thousands of dollars and not refundable. The franchise fee can be paid up-front or in a series of installment payments.

Franchise owners also pay advertising and royalty fees to the parent company. These fees cover the parent company’s national advertising campaigns, which also benefit the individual franchise owners. Advertising and royalty fees are typically paid as a percent of sales and on average can cost 2-10 percent.

When opening a new franchise, applicants must provide documentation showing they meet the company’s net worth requirements. The parent company wants to make sure the franchisee has the asset base necessary to support the new business. Applicants do not necessarily need to pay for all of the start-up and franchise fees out of those assets.

There are several franchise financing options available. Many companies provide financing plans for qualifying franchisees either through their own company or through a third-party partner financial institution. If a franchise does not offer a financing program, a small business loan is another option.

What is a Small Business Loan?

A small business loan is a loan from a financial institution for the purpose of starting a new small business or investing in property and equipment needed to grow a small business. Lenders are notoriously reluctant to lend money for the purpose of starting a new business. Borrowers applying for small business loans through a local lender will need to provide pro forma financial statements, business plans, and details about the value of the underlying loan collateral.

In addition, the borrower is typically personally liable for the outstanding debt since the acceptance or denial is based on the individual’s credit rating and wealth before any business performance has been established. Small business owners don’t have a great track record in getting approved for a small business loan through a local lender because the loans are considered to be risky.

The process of getting a small business loan may be less challenging for a franchise owner with an established business. The owner of an existing franchise might want to get a small business loan to renovate the location, invest in new equipment, or open a new location.

The risk associated with this type of loan is much lower since the borrower can provide financial statements showing the franchise performance and ability to generate the cash flow necessary to repay the loan. As a result, local lenders are more likely to provide small business loans to already established local businesses.

What Types of Small Business Loans Are There?

A small business loan through a local lender could be a good option if you already have an established business relationship with the bank. These loans can be either a line of credit or a traditional term loan. The average small business loan can vary dramatically in both amount and interest rate. All will require substantial amounts of documentation about the business's financial prospects as well as the personal credit rating and net wealth of the borrower.

Another type of small business loan is guaranteed by the Small Business Administration (SBA), which is a federal agency. The federal government guarantee allows lenders to offer loans to small businesses at lower interest rates and with more favorable terms. The SBA 7(a) loan program is the agency’s most popular option. These loans have a guarantee for up to $5 million and cover expenses associated with expansion, equipment, and working capital management.

The SBA has another loan program, called the 504 program, which provides guaranteed loans of up to $5 million for the purchase of land, machinery, and facilities. SBA loans also give borrowers longer maturities compared to other small business loans.

Can I Get a Small Business Loan Online?

Many lenders allow you to apply online for a small business loan. Financial institutions offering their own loans may be able to process the online loan application and give you an answer in just a few hours. Since SBA loans require more documentation to meet federal underwriting guidelines its process can take longer to complete. It is, however, possible to pre-qualify online for an SBA loan in a matter of minutes.

What Are the Costs and Benefits of a Small Business Loan?

Small business loans, including SBA loans, consider the borrower’s personal credit history and do require personal liability. Since the application considers personal credit history, a borrower can have a much more difficult time being approved for a small business loan with a history of late payments, balances near the maximum amount, or prior bankruptcy.

Also, only borrowers with the best credit scores get the best rates on small business loans. In some ways, the loan approval is related just as much to the individual borrower’s prior credit as it is to the outlook of the business's success.

In addition to the federal government’s guarantee, SBA loans require personal guarantees from all owners with at least a 20 percent ownership stake, as well as from all top management positions. By pledging a personal guarantee on a small business loan, the owners and managers are placing their own personal assets at risk.

In the event that the business defaults on the loan, the lender can pursue compensation from the business owners and managers. Personal liability for business debt is risky because it puts all personal income and assets at risk for the repayment of business debt.

Small business loans, however, are a great franchise financing tool. Here’s why.

First, small business loans allow a borrower to obtain franchise financing for high dollar amounts that would not otherwise be available through a credit card or personal loan. Second, small business loans could have repayment terms that are favorable for business owners. Third, small business loans, particularly those guaranteed by the SBA, have lower interest rates than many other franchise financing options.

While interest rates on non-SBA loans to borrowers without an excellent credit rating can be similar to the range of credit cards, most are lower. In fact, interest rates on SBA loans are usually less than 10 percent. So a small business loan can be an essential factor in financing the purchase of a new franchise or growing an existing franchise business.

Author: Jeff Gitlen