Franchises are probably the most straightforward way to start a small business. Individuals can take a proven successful business model, invest their own time and capital, and hopefully duplicate the success of an already-established brand. That’s why over 12,000 open in the United States each year. And while the start-up process is relatively simple, finding the money to do it is not always so easy.
The most common place to obtain financing for a franchise is from family and friends. Yes, it would be nice if we all had a rich Uncle Pennybags who could just fork over a quarter-million dollars to start up a franchise, but not everyone has relatives with that much money. That doesn’t mean you’re stuck, though. A number of financing options exist for anyone starting a franchise.
First Things First: Get Your Ducks in a Row
Before you can even begin to think about asking complete strangers to loan you hundreds of thousands of dollars, you’ve got to show them you’re not a high-risk proposition. The first step in doing this is creating a statement of your net worth. Your accountant can prepare this for you, but lacking one of those, it’s not exactly advanced calculus. Simply take all your assets – cash, checking/savings accounts, investments, property, automobiles, securities or anything else you have – and subtract liabilities. These would be credit card bills, auto loans, mortgages, student loans, or anywhere else where you owe money. Put them both on a ledger sheet and, voila! Net worth.
Secondly, obtain a Franchise Disclosure Document from your franchisor, which explains all of the costs that will be involved in opening the franchise.
Third, write out a business plan. Otherwise, how can you justify how much money you’re going to need? Calculate in costs beyond the franchise fee like build-outs, equipment, hiring costs, insurance and the like so you’ve got a credible breakdown of the funds you’ll need. Once you’ve got that set up, and know how much you’ll be asking for, it’s time to figure out where to get the money.
Conventional Bank Loans
Strolling into a bank and asking for money to start a franchise might seem like the most-straightforward way to get a loan. But it’s also probably your lowest-percentage shot. Lacking a proven track record and/or loads of collateral, banks will be hesitant to loan money. They will typically require a 20-30% down payment, and tend to favor people with whom they have established relationships. So if you’ve got a bank you’ve been working with for years, start there.
Interest rates can vary greatly, again dependent on stuff like net worth, the size of the loan, and your credit history. But typical rates are around 7-8% for loans under $100,000, and 6-7% for loans over $100,000. Also, traditional banks like businesses with proven track records and proven success, so your choice of franchise can make a considerable difference.
If a commercial bank isn’t so keen on your proposal, the Small Business Administration (SBA) might be your best option. The SBA provides loans backed up to 90% by the Federal Government, that are intended for small businesses who might otherwise not be able to find financing. About 10% of all SBA loans go to franchisees, and franchises are a much easier sell since the SBA can more easily predict how a franchise will perform. It even has a franchise registry, and if the franchise you’re looking to open is on that registry your loan process can go 2-3 times faster. The average loan has a 7-9% APR and is somewhere between $250,000-$500,000, thought it can go up to $2 million for the right borrower.
It’s not a cure-all for franchise financing, though. SBA loans require a credit score of at least 650, and come with variable interest rates. So make sure your projected cash flow is enough to cover rate hikes.
Some franchisors have financing programs built in to their application process, that allow you a few different options. This can be anything from a deferred franchise fee to interest-only loans with large balloon payments once the franchise is up and running. Be warned, though, interest rates from franchisors can be considerably higher than from banks and the SBA. Fifteen percent APR is not unheard of, so you may not want to make this your first option.
Others have what they call “preferred lenders,” essentially banks and other institutions that the franchisor works with consistently, and will typically give you better rates. They’re also familiar with how much money franchisees need for things like operations, hiring costs, and ongoing royalties.
Finally, alternative lenders can be a quick, easy, low-hassle way of getting franchise funding you need. Typically, though, alternative lenders are best for existing franchisees, who are looking to expand, renovate, increase working capital or upgrade technology and equipment. BFS Capital, for example, offers dedicated franchise advisors who can walk you through the process, and get you pre-approved in 24-hours. And the application process won’t involve a whole lot beyond providing sales history that supports your ability to pay back.
While alternative lenders are without a doubt the simplest and fastest way to get franchise funding, they also carry higher interest rates than banks and the SBA. And again, part of why the approval process is so fast is because applicants have existing franchises that demonstrate a profit. For a new franchise, this method may not be the best option.
So while finding the money to start a franchise is tough, it’s not impossible. Many options exist for you to start or expand a franchise, and as long as you know what to expect and go in prepared, the experience can be relatively painless. Risk is always involved, but as a small business owner that’s something you’ve come to expect. And even if your friends and family can’t afford to help you out, there are still plenty of people out there who want to.