What Funding Can You Get for Franchises?

Franchise business loan options

Just as when you’re starting a business traditionally, entrepreneurs and small business owners who are considering opening a franchise must research financing options. While small business loans are possible, there’s more than one way to get the capital you need. 

Here are some financing methods to consider for your franchise:

1. Obtain financing from franchisors.

As a potential business franchise owner, you’re in a unique position: You’re effectively helping a much larger business expand into a new market. As such, that business has an incentive to make it easier for you to get your business running. For this reason, parent companies sometimes offer in-house financing options to help franchisees cover costs.

“Your first port of call for finance should be your franchisor, who may be able to offer you money,” advised Ethan Taub, CEO of Debtry.

Franchisor financing can be an ideal solution for new franchisees. However, there are some caveats to consider. For example, the franchise has virtually all the power in loan negotiations. Unlike other lenders, the franchisor has no incentive to offer flexible loan terms or otherwise accommodate your unique needs.

As you discuss this option with the franchisor, get a rundown of its funding requirements and loan contract terms before you agree to anything. After comparing the franchisor’s offer with offers from outside lenders, you’ll better understand what option best suits your situation.

2. Ask for loans from friends and family.

Consider asking for loans from friends and family. These loans usually come with little or no interest and lenient repayment terms — perhaps their biggest advantage. And if times get dire, your loved ones might even forgive the loan. 

However, like all financing types, family and friend loans aren’t perfect. Asking loved ones for money may be uncomfortable, especially during uncertain financial times, and borrowing money can create a wedge between even the closest friends and family members. 

If you pursue this option, draw up an agreement in writing, and commit to meeting repayment expectations.

3. Apply for a commercial bank loan.

Getting a business loan from a bank is a common way to obtain franchise financing. Traditional term loans from banks provide money upfront; you repay the loan over time in monthly installments with interest. This predictable payment structure is a key advantage of bank loans. They also have relatively low interest rates, though other loan types may offer lower rates.

However, bank lenders are risk averse, so qualifying for a loan may be challenging. Lenders want to ensure you’re a creditworthy borrower. The bank loan process can be tedious and time-consuming as the lender gathers significant paperwork — a major disadvantage.

A bank usually requires additional information, including your credit score, some collateral, a business plan and yearly revenue. The better your financial standing is, the better rates and terms you’ll receive. 

According to Emily Deaton, a financial journalist at LetMeBank, a franchise’s established business presence could work in your favor. “Banks will feel more confident in providing you a loan if you’re franchising an established company rather than starting your own company from scratch,” Deaton said.

4. Apply for an SBA loan.

If you don’t qualify for a traditional bank loan for your small business, one of the best avenues to explore next is an SBA loan — specifically, the 7(a) loan. Banks and other lenders approve and fund SBA loans, but the SBA partially guarantees them. As such, lenders are willing to offer a lower interest rate and longer terms, which are significant advantages of SBA loans. Your monthly repayment costs can be lower with SBA 7(a) loans than through other financing vehicles.

However, SBA loans are notoriously tedious to apply for, and the application process often involves long waiting periods. They may not be a viable option if you need your franchise funding quickly. If that’s the case, other funding options may be better.

5. Pursue alternative lending options.

Franchisees can also consider alternative lenders. These options tend to offer faster funding and approve more borrowers. However, there are some caveats to keep in mind. 

Options such as unsecured loans, business financing that borrows against your 401(k) or investments, and various types of credit often result in a quick infusion of cash. However, this comes at the expense of higher interest rates and shorter repayment periods. 

Although alternative funding options may be more expensive than traditional financing routes, they may be worth considering if you have bad credit and can’t get approved for more traditional financing options.

What to consider when choosing a franchise loan

Before you open a franchise location, consider the overlooked costs and realistic expenses involved. Generally, you need thousands of dollars for each step in the franchising process. So unless you have the cash on hand, you’ll need financing.

Here are some expenses you should expect to cover:

• Legal fees: You’ll incur legal fees when using a franchise attorney to review the franchise agreement.
• Real estate costs: Consider real estate and build-out costs for your newly selected franchise location.
• Franchise fee: You’ll need to pay a franchise fee that can range from $20,000 to $50,000, on average.
• Additional costs: Supplies, inventory and day-to-day operations will require additional funds.

Here are additional considerations you should take into account when securing a franchise loan: 

• Check for approved funding-use stipulations. Some lenders apply stipulations for what constitutes approved funding use, so double-check the lender’s rules before you apply.
• Look beyond the principal. Carefully determine how much money you need to borrow, how long the repayment term will be, and the monthly interest rate in addition to the principal. Those three points are essential considerations — they’ll determine your minimum monthly repayment costs and how long those payments will last.
• Determine if you must provide collateral. In asset-based lending, you must provide collateral for your loan. Weigh the pros and cons of pledging collateral.
• Understand the loan’s logistics. You must also consider how extensive the application process is and how long it will take to receive your funds.

The benefits of getting a franchise business loan

Funding your franchise location through a loan offers the following benefits:

• A franchise loan covers massive costs. Launching a franchise location can cost hundreds of thousands of dollars; your business probably doesn’t have this amount of cash on hand. Franchise business loans may be the fastest way to obtain this money and start working toward your business goals. You can use your loan proceeds in any manner your loan agreement permits.
• A franchise loan boosts cash flow. The more accounts receivable funds your business converts to cash, the better your cash flow will be to cover expenses. However, you can’t always control your accounts receivable funds. When you’re straddled with unpaid client invoices, franchise business loans can compensate for your missing cash flow.
• A franchise loan helps you retain ownership. With non-loan funding options such as venture capital and angel investors, you may lose a stake in your company. You may even give up control over key business decisions. Franchise business loans eliminate this risk; they don’t affect your ownership stake in your franchise location.
• A franchise loan can be financially savvy. It can be tempting to apply for a business credit card to cover some business purchases. However, credit card funding lines are often too small to cover key franchise business startup costs. Plus, credit card interest rates can be high, making expenses you fail to repay especially costly. Franchise business loan rates are typically lower than card rates, and the loans usually offer enough cash to cover all of your expenses.

How to get approved for a franchise business loan

All loans and lenders differ, so make sure you get a detailed list of requirements for your franchise business loan. Here are some general tips to get started:

1. Have a business plan to share with the lender.

Lenders are risk averse; they require extensive knowledge of what their funds will finance. Most lenders will want to understand your business.

“You need a business plan to be able to get a business loan, with prospects that you can pay them back the amount that you want to borrow, with evidence where possible,” Taub said. “You have to have a plan in place so that you can pay the money back. That is the most important thing that they ask for when you borrow money for a business.”

As a franchisee, you have a leg up over entrepreneurs of brand-new businesses, especially if the franchisor is a well-known business. Still, the lender will likely want your business plan, so be ready. 

2. Work on your credit score to help your franchise loan approval odds.

Your credit score matters when you’re applying for a franchise business loan. Credit scores are determined by several factors, including the amount of credit you have, how much credit you’re using at any given time and how frequently you make on-time payments. If you have a high credit score, lenders offer lower interest rates and longer terms; your score shows you’re responsible with the money lent to you. The opposite happens if you have a lower credit score.

Because you won’t have a business credit score, your personal credit score will likely come into play when you’re applying for a franchise business loan. If you know you’ll need a good credit score ahead of time, work on increasing that number.

3. Be prepared to make a down payment or pledge collateral.

Some lenders feel comfortable providing a franchise business loan only if the borrower provides a down payment or some sort of collateral. If this is the case, it’s important to determine how much of a down payment or collateral you’ll need for your loan to be approved.

• Collateral: If collateral is required, draw up a list of your assets, determine their market value and decide which ones you’re willing to put up as collateral. Remember, if you fail to pay your loan and things get dire, the bank will collect on that collateral by selling the assets to make up the lost funds. Assets include real estate, business equipment, stocks and home equity.
• Down payment: A down payment serves as another method for lenders to reduce risk. A down payment demonstrates how serious you are about obtaining this loan and investing in your business, since it usually requires a substantial investment. “Down payments do vary depending on the type of franchise you are interested in, but initial fees can be from $500 to $2,000,” Taub noted.

Funding your franchise on the right foot

With the right funding source for your franchise, your startup and operating costs can be easy to cover. Numerous funding options with significantly different terms are available. That may seem overwhelming initially, but ultimately, it’s a good thing. As you spend time comparing and contrasting terms, the right loan for your needs will become clear. If you apply and get approved, you’re well on your way to franchising success.

Andrew Martins contributed to this article. Source interviews were conducted for a previous version of this article.