November 10, 2020 | 5-minute read (945 words)
Many people want to start their entrepreneurial journeys by opening a franchise, but don’t have the money to do so. Although buying a franchise can be less expensive than starting a business from the ground up, it still requires significant capital investment. Since the business model has already been tested and proven to work, raising capital may be easier than starting your own independent firm.
A franchise is a commercial and legal agreement between the franchisor (owner of a company) and the franchisee (an individual who is starting a franchise or branch of that company using the company’s name, products and trademarks). The franchisee sells the goods and services that the franchisor provides.
Check out seven financing options that will allow would-be franchisees to fund their businesses so you can get a feel for what might suit your needs.
Financing from Franchisors
Many franchisors help new franchisees find lenders or introduce them to lenders who are likely to accept their loan applications for starting a franchise. Some prospective franchisors may even guide their franchisees through the process of the loan application or help them access loans through their partnered lenders.
Some franchisors also offer customized financing solutions to their franchisees, either through partnerships with specific lenders or by providing capital directly themselves. As you discuss this option with your franchisor, make sure you understand all the requirements and financing terms before agreeing to anything. Then compare the franchisor's offer with other sources of financing available to you and select the one that best suits your needs.
Franchise Financing Companies
Several franchise financing companies match borrowers with the perfect lenders for their financial needs or lend directly to new franchisees. Some companies also advance cash to new franchisees on good terms if they franchise a highly-reputable business. Some lenders also prefer certain franchise businesses over others if they have worked with the brand before and had no problems with repayments on loans.
Commercial Bank Loans
A traditional term loan from a bank provides you with a lump sum of money upfront, which you then repay with interest in monthly installments over a defined period. The stronger your financial history and the higher your credit score, the better the terms and interest rate you will receive for your term loan to finance your franchise.
Despite the tendency of commercial banks to favor franchise businesses, you still have to fulfill the bank's lending requirements. In some cases, you may also have to provide collateral to secure your business loan.
When you apply for a commercial bank loan to purchase a franchise, your lender will review your business plan, net worth and credit history to determine whether you can repay the amount that you want to borrow.
SBA loans are approved and funded by banks and other lenders, but a portion of the loan amount is guaranteed by the U.S. Small Business Administration (SBA). SBA loans offer lower interest rates and longer repayment terms, so your monthly repayment costs can be lower than through other financing options.
The SBA loan is relatively easier to secure with the franchise business model because the SBA earmarks a portion of its loan allotment specifically for franchises. However, before applying, make sure to verify whether the franchise you’re interested in is registered and approved by the SBA Franchise Directory.
Loan applications from franchises that are already registered by the SBA are often processed faster than other loan applications. The SBA already has the required information for evaluating the franchise agreement, which streamlines and simplifies your loan application process.
Franchisors may help their franchisees during the loan application and qualification process via a guarantee program. They may agree to pay off a defined loan amount in case the franchisee is unable to pay it back themselves.
Make sure you review the terms of both your franchise and financing agreements before you sign to understand the financing terms or avoid any deferred payments. Many of these programs offer to finance not only the franchise fees but also the money needed to purchase resources you need to start a franchise.
Loans from Family and Friends
If you choose to take a loan from a friend or family member, be sure to write up a contract that includes repayment terms and expectations to avoid any future disagreements.
Alternative Lending Options
If you need funds for your franchise quickly, have a bad credit score or are unable to secure a traditional loan, you may consider a loan from an alternative lender. Alternative loan products tend to be more expensive, but they typically have less stringent requirements.
Alternative lenders offer a variety of loan options with shorter repayment periods and higher interest rates, such as unsecured loans, business financing against retirement or other investments and equipment financing. Some websites crowdfund for specific industries and business types, which is another alternate lending option.
Points to Check
There are some essential expenses that every entrepreneur looking to start a franchise has to manage. While selecting a franchise business loan, make sure that it is sufficient to cover some or all of the following costs.
- Legal fees for a franchise attorney to review the franchise agreement.
- Real estate and setup costs for your newly selected franchise location.
- A franchise fee, along with ongoing royalties and advertising costs.
- Supplies, inventory and hiring staff to handle day-to-day operations.
Always check the following four critical points before applying for a loan to determine your monthly installments.
- Amount of money you need to borrow.
- The repayment period of the loan.
- Rate of interest charged per month in addition to the principal.
- Other terms and conditions of the loan.