Overview of Franchise Financing
Many people choose to start or buy a franchise instead of forming their own business from scratch. A franchise comes with a proven business model and instant name recognition. Bonus: it's easier to get franchise financing than it is to get a loan for a non-franchise business.
How Franchise Financing Works
There are two main sources of franchise financing: SBA loans and conventional bank loans.
SBA Loans
SBA loans are the cheapest sources of capital for financing a franchise. These loans are partially guaranteed by the U.S. Small Business Administration, resulting in lower interest rates and longer repayment terms. You typically need to bring at least 10 % down to the table to get an SBA loan.
The Small Business Administration (SBA) is more likely to loan money to a franchise than other types of businesses. The SBA even has a franchise registry. If the franchise you want to start is included in the registry, your SBA application will be expedited. There’s no guarantee you’ll get a loan, but you will benefit from a faster application process.
Standard Bank Loans
In addition to offering SBA loans, banks offer traditional commercial loans for starting a franchise. For these loans, you will typically need to provide 20-30 % down payment and collateral. Collateral can come from personal and/or business assets.
Work With the Franchisor Whenever Possible
We always recommend working closely with the franchisor when you’re trying to get franchise financing. Many franchisors have relationships with preferred lenders that will give you the best rates. In addition, several franchisors offer some type of in-house financing. For example, some franchisors will offer you a loan to cover the initial startup fee. In-house financing usually isn’t enough on its own to cover the entire cost of buying the franchise, but it can be helpful when used in combination with bank financing.
How Franchise Financing Works
There are two main types of loans for a franchise: SBA loans and standard bank loans.
SBA Loans
Both SBA 7(a) loans and SBA 504/CDC loans can used to finance a franchise. These are the cheapest sources of capital for a franchise. They are partially guaranteed by the U.S. Small Business Administration (SBA), resulting in lower interest rates and longer repayment terms. In addition, SBA loans typically require a smaller down payment and less collateral than you would need for a standard bank loan.
The Small Business Administration (SBA) is more likely to loan money to a franchise than other types of businesses. The SBA even has a franchise registry. If the franchise you want to start is included in the registry, your SBA application will be expedited. There’s no guarantee you’ll get a loan, but you will benefit from a faster application process.
Standard Bank Loans
In addition to offering SBA loans, banks offer traditional commercial loans for starting a franchise. For these loans, you will typically need to provide 20-30 % down payment and collateral. Collateral can come from the real estate on which the franchise is located or from the equipment, fixtures, and other physical assets that you purchase with the franchise loan. In rare cases, you may be asked to pledge your home as collateral.
Work With the Franchisor Whenever Possible
We always recommend working closely with the franchisor when you’re trying to get financing. Many franchisors have relationships with preferred lenders that will give you the best rates. In addition, several franchisors offer some type of in-house financing. For example, some franchisors will offer you a loan to cover the initial startup fee. In-house financing usually isn’t enough on its own to cover the entire cost of buying the franchise, but it can be used in combination with bank financing.
Will I Qualify For Franchise Financing?
It’s typically easier to get a franchise loan than a loan for a business you’re starting from scratch. In most cases, the following is necessary to qualify for franchise financing:
- A quality franchise opportunity
- A good credit score (ideally above 660)
- Down payment of 20-30 %
- Collateral
The quality of the franchise opportunity can determine whether you qualify and other loan terms. For example, if you’re starting a McDonald’s at a prime downtown location, you may get more easily approved with favorable terms. On the other hand, if you’re starting an Uncle Bob’s Chicken franchise at a run-down part of the city, you may have a harder time qualifying for a loan.
Before you sign a franchise agreement, the franchisor must give you a Uniform Franchise Disclosure Document (UFDD). This document shows the costs needed to start and run the franchise, such as marketing costs and supply costs, and can be used to calculate the size of loan that you’ll need and the corresponding down payment.
Cost of Franchise Financing
The terms of your franchise loan, including the interest rate you pay, depend on your credit score and publicly available data about the franchise’s performance. Through the franchise registry, lenders can view historical financial and loan data for your franchise.
The more popular and profitable your franchise is, the better your interest rate will be because the bank is confident that you will generate a high income and be able to pay back the loan.
SBA loans typically have interest rates of 6-7 %. The SBA sets a maximum limit on the interest rate that can be charged on SBA loans.
Bank loans typically have interest rates in the range of 5-15 %.
Interest rates on in-house financing offered by some franchisors run a bit higher than this.
