Purchasing a franchise allows you to own a business with the support of an established brand. For many entrepreneurs, the biggest hurdle is securing the necessary capital. Financing a franchise involves understanding the full investment scope and navigating various funding sources, which requires careful planning and knowledge of what lenders and franchisors expect.
Determine Your Total Investment
Before seeking funding, you must understand how much capital your venture requires. This calculation must account for all expenses from signing the agreement through the initial operating months. These costs include real estate, build-out expenses, equipment, signage, initial inventory, and fees for legal or consulting services.
A resource in this stage is the Franchise Disclosure Document (FDD), which every franchisor must provide. Item 7 of the FDD outlines the estimated initial investment as a range, offering a detailed breakdown of these expected costs.
Beyond setup expenses, you must calculate the need for working capital. This fund covers daily expenses like payroll, rent, and marketing before the business generates sustainable cash flow. Accurately estimating this total figure is a foundational step, ensuring you seek the right amount of funding to launch and sustain your franchise.
Explore Common Franchise Funding Options
Once you have a clear financial target, the next step is to explore the various avenues available for funding.
SBA Loans
One of the most popular financing routes is a loan backed by the U.S. Small Business Administration (SBA). These are not direct government loans; they are issued by lenders like banks, with a portion guaranteed by the SBA. This guarantee reduces lender risk, resulting in more favorable terms like lower down payments and longer repayment periods.
The most common program for franchise financing is the SBA 7(a) loan, which can be used for working capital, equipment purchases, and real estate. To be eligible, the franchise must be listed on the SBA’s Franchise Directory. Applicants need a strong credit score, 690 or higher, and must be prepared to make a down payment of at least 10%.
Traditional Bank Loans
Conventional business loans from banks and credit unions are another option. These loans can offer competitive interest rates for applicants with a strong financial track record. They can be more difficult to secure than SBA-backed loans, requiring a higher credit score, a substantial down payment, and significant collateral.
An established relationship with a bank is beneficial, as is working with institutions experienced in franchise lending. While the approval process can be stringent, a traditional bank loan remains a solid choice for well-qualified individuals.
Franchisor Financing
Many franchisors offer their own financing programs or have established partnerships with preferred third-party lenders. This is an attractive option because the franchisor has a vested interest in your success. This can streamline the approval process, as the lender is familiar with the franchise’s business model.
While some franchisors provide direct funding, they more commonly facilitate loans through their network of financial partners. The terms of these loans can vary; some may offer competitive rates, while others might have higher interest rates than traditional bank loans.
Rollovers as Business Startups (ROBS)
A Rollover for Business Startups (ROBS) allows you to use funds from an eligible retirement account, like a 401(k) or IRA, to fund a business without early withdrawal penalties or taxes. This is not a loan, so there is no debt or interest to repay. The process involves creating a C-corporation and a new company retirement plan, where you roll over your existing retirement funds.
Those funds are then used to purchase stock in your new corporation, providing capital for your business. This method offers debt-free funding but is a complex process requiring adherence to IRS guidelines. The primary risk is that you are investing your retirement savings, which could be lost if the business fails.
Alternative Personal Funding
Many franchisees use personal assets to cover a portion of their startup costs, particularly the down payment. Common sources include personal savings, home equity lines of credit (HELOCs), and loans from friends or family. A HELOC allows you to borrow against the equity in your home and can come with lower interest rates than other types of loans.
Leveraging personal assets can jeopardize your financial security if the business struggles. These funding sources are best used to supplement a primary loan rather than to cover the entire investment.
Strengthen Your Loan Application
Securing a loan requires presenting yourself as a low-risk, credible borrower. A well-prepared submission that details your financial history, business acumen, and planning can significantly improve your chances of approval.
A strong personal credit score is a component of a compelling loan application. Before applying, review your credit report for errors and take steps to improve your score, such as paying down existing debt.
Your business plan is another component. While the franchisor provides a business model, lenders expect a customized plan with local market research, financial projections, and your strategy for success. The plan should also highlight your relevant management or industry experience.
Lenders want to see that you are personally invested, which is often called having “skin in the game.” This takes the form of a cash down payment from your own funds, which demonstrates your commitment and shares the financial risk with the lender. Assembling financial documents like tax returns and bank statements will give lenders a clear picture of your financial standing.
Compare Financing Offers
After submitting applications, you may receive multiple loan offers. It is important to look beyond the interest rate and consider the total cost of the loan over its life to select the best option.
A figure to compare is the Annual Percentage Rate (APR), which provides a more complete picture of the loan’s cost. The APR includes the interest rate plus lender fees and other charges, expressed as a single annual percentage. Two loans might have the same interest rate but different APRs, making the APR a more accurate comparison tool.
You should also examine the loan term, which is the time you have to repay the loan. A longer term may mean lower monthly payments but more total interest paid, while a shorter term means higher monthly payments but less interest paid overall. Finally, check for prepayment penalties, which are fees charged if you pay off the loan early.