If you’ve decided to join the millions of business owners who start their own businesses by becoming a franchise owner, you’re going to need money: sometimes a lot of it. Franchise start-up costs can run from thousands to more than a million dollars for some of the most popular restaurant franchises. Franchises financing is available, but you’ll need to know where to look.
While many of the top franchises require a franchisee to have substantial assets and/or net worth, there are plenty that can be purchased for $50,000 or less, and it may be possible to finance all or part of that cost.
The Process of Purchasing a Franchise
Buying a franchise can be straightforward if you know what you’re doing. Finding financing isn’t the first step, either.
A typical franchise purchasing process looks like this:
1. Doing Your Research
Find the right franchise for you based on what you’re good at, what you’re interested in, and how much money you have. You’ll also want to know how much investment you’ll need to make long-term as well as what the competitive field looks like.
2. Contacting Franchisors
Once you’ve found a couple of franchises that best match your ideas, you’ll fill out an application from the franchisor so they can determine if you’re a good fit for them.
3. Attending a Franchisor Discovery Day
In order to better get to know you and for you to understand their business, a franchisor will hold a discovery day, usually in their office.
4. Reviewing Franchise Agreements
You’ll receive a formal contract called a franchise agreement once you and the franchisor have agreed it’s a good fit. As with most contracts, you can hire a lawyer to review it with you to make sure you understand it.
5. Secure Financing
Financing can help you cover the costs of owning a franchise, including the franchise fee, day-to-day costs, rental and mortgage costs, construction costs, equipment costs, and more.
6. Choosing a Location
While there are many work-from-home franchises available, if you decide to purchase a location-based franchise like retail or restaurant services, you’ll need to choose where to operate your franchise.
At a minimum you’ll require training as the franchise owner to ensure you understand the ins and outs of running the business. If you have employees or staff, you need to make sure they’re also fully trained on day-to-day operations.
The final step in purchasing a franchise is opening it! Sometimes the franchisor will help with marketing and promotional materials, but throwing a grand opening is also a great idea to kickstart your business in the community.
What is Franchise Financing?
Franchise financing may be used to fund a franchise. Financing may be available to:
- Acquire an existing franchise,
- Purchase a franchise,
- Finance real estate,
- Remodel a store front,
- Purchase inventory, and/or
- Purchase equipment and other assets.
Can You Get Financing for a Franchise?
Yes, it is very common for business owners to use financing programs to open or acquire a franchise business, and there are a variety of financing solutions that may be available to you.
Here, we’ll describe seven of the most popular ways to finance a franchise.
Seven Ways to Finance a Franchise
1. Franchisor Franchise Loan
Some franchise brands offer financing and if your prospective franchisor offers financing, it’s definitely worth considering. The franchisor may provide information about financing on its website. In addition, at least 14 days before you purchase a franchise, the franchisor must provide you with federally-mandated Franchise Disclosure Document (FDD). This document will contain information about any franchise loan offered through the franchisor. (Financing may be extended through a partner lender, rather than the franchisor itself.)
This could be a potentially good source of funding because the source of the financing will be familiar with the franchise and its offerings. Nevertheless, you’ll want to shop around because you may be able to find cheaper funding on your own, especially if you have strong credit and meet other lender qualifications.
2. Bank Loan
A bank or credit union may finance a franchise. While many banks shy away from lending money to a brand new business, franchising may be different. Some banks are eager to make franchise loans, especially to those with good credit who are purchasing a franchise with a solid track record and proven business model.
Bank loan products in general require substantial documentation. The owner’s personal credit score, as well as business credit (if available) will likely be evaluated. The bank may also want to see a business plan. Traditional financial institutions tend to be fairly conservative, so if you’re purchasing a new franchise that doesn’t have a well-established track record, you may find it difficult to get to a “yes.”
Banks also often will insist that the franchise owner put up collateral; you may even have to pledge equity in your home if you don’t have business assets that can be used as collateral. You’ll also need skin in the game. In other words, the bank may require you to contribute at least 20— 25% of the upfront costs out of your own funds.
Banks generally offer several different loan options, including term loans (a fixed amount of money for a fixed period of time) as well as lines of credit (where you borrow what you need up to an approved credit limit). Term loans work well when you have a specific project you’re trying to finance, while lines of credit are usually appropriate for working capital and cash flow needs.
3. SBA Loan
Loans guaranteed by the Small Business Administration (SBA) offer attractive rates and repayment terms. The SBA doesn’t make loans, though. Instead, it partners with financial institutions to guarantee a significant portion of the loan if the borrower defaults. The SBA sets certain requirements that lenders must follow in order to get the guarantee; financial institutions may have additional requirements. That means it is possible to shop around for an SBA lender that’s the right fit for the type of business you want to open.
Not surprisingly, these loans do require a fairly extensive application process and the applicant should have good credit and contribute funds toward the purchase. You don’t have to have collateral to qualify for an SBA loan, but if you do, the SBA will expect you to pledge collateral (including, potentially, home equity).
There are several types of SBA loans. The SBA 7(a) loan program is one of the most popular for franchise financing. This program offers up to $5 million, usually with 10-year repayment periods, however, loans for equipment may extend to 25 years (or useful life) and real estate loans may also extend repayment periods up to 25 years. (The PPP loan program is a type of 7(a) loan.)
It’s worth noting that for 7(a) loans for $350,000 or less, the lender must review the applicant’s FICO SBSS score, which takes into account the owner’s personal credit as well as the business credit of the business itself (if available).
4. Alternative Financing
There is no shortage of online lenders offering financing to small businesses. These lenders are often referred to as “alternative” lenders, in contrast to traditional lenders such as banks.
If you’re a first-time small business owner, you’ll likely have trouble getting one of these loans to start a franchise. Most require a minimum number of months in business and a minimum amount of annual revenue ($50,000 or more is not uncommon). That means this type of financing is often off-limits to a start up. Instead, it may prove helpful once your franchise is established and you are looking to grow your current business or purchase additional locations.
5. Retirement Funds
If you have a 401(k) or 403(b) retirement account, you may be able to borrow against it to fund your business. (You can’t borrow against an IRA but you may be able to purchase a business— including a franchise— using a Rollover for Small Business (ROBS) or by withdrawing funds from a ROTH IRA.)
In fact, ROBS plans are very popular for financing franchises. With one of these plans, retirement funds are rolled into a ROBS plan in a tax-free transaction. The ROBS plan then uses the rollover assets to purchase the stock of the new business. If you choose to go this route, make sure you work with a reputable firm. The IRS warns that “while not considered an abusive tax avoidance transaction, (they) are questionable because they may solely benefit one individual.”
If you choose to tap retirement funds, be very cautious and get advice from a tax professional. Many businesses don’t survive the first five years. If you use retirement funds and your business fails, or if you fail to follow IRS guidelines, you may wind up with a big tax bill and a compromised retirement, in addition to the headache of closing a business.
6. Small Business Credit Card
Small business credit cards may feature high credit limits. That means it may be possible to finance a low-cost franchise with a balance transfer where the funds are deposited into your business bank account. This approach carries risks, of course; once the low introductory rate expires, you can be looking at a pretty hefty interest rate on your balance. So you’ll need to get your franchise off the ground and make money quickly so you can pay off your balance or refinance.
A more likely scenario is to use business credit cards to supplement other types of financing or to pay for day-to-day expenses, and finance major purchases. Credit cards are often best used as a form of short-term financing to help smooth out cash flow.
Many small business credit cards do not report to personal credit unless you default (you’ll want to confirm this with your card provider), so it won’t affect your personal credit as long as you make your payments on time. As an added bonus, most small business cards help build business credit, which can be valuable as your franchise grows and seeks additional financing.
7. Equipment Financing
You may be able to get financing for equipment you plan to purchase for your franchise. There are a variety of funding options for businesses that need to make significant investments in equipment. These may include leasing equipment, equipment financing (where the equipment serves as collateral for a loan) and even sale-leaseback arrangements where the business can get cash for existing equipment.
Because the equipment serves as collateral it may be easier to qualify for this type of financing, but lenders will still want to make sure the business is likely to be successful, and so a credit check and careful underwriting will still be involved.
Costs of Opening a Franchise
There are as many different franchise options as there are businesses, so the costs of financing a franchise will vary depending on the business it’s in, the particular franchise, and whether or not they require you to maintain a cash reserve. There are franchises with startup costs as low as $10,000 up to $5 million, depending on the type of franchise you’re purchasing. For example, a home-based franchise might be on the low side, while a hotel franchise could be on the higher end of the range.
What’s more, you’ll have professional fees (like an attorney to review the contract and your accountant to help you determine if the numbers make sense). You’ll also have the costs of building out the store or office where you will operate your franchise, even if you plan to operate the franchise out of your home. You should also expect inventory, equipment, insurance, business licenses, rent, landscaping, signage — basically many of the things you will need to start any business. Fortunately, the individual franchise will make the decisions of ‘what you need to buy’ easier, but startup costs can still add up — in addition to your franchise fee. The franchise fee will generally run between $20,000 to $30,000, but there are some that can be much more than that if it’s a very established brand with a great reputation.
It’s probably a given that you’ll need a reserve of working capital for a year or two to make sure you have enough capital for business operations as you get your franchise off the ground. An experienced franchisee will likely tell you that two years of working capital is enough, but you’ll have to watch every penny you spend because even with a two year reserve, it’s easy to run out of capital before the two years is up.
Things to Consider Before Financing A Franchise
Before getting financing for your franchise, there are a number of things to consider. First, your financial situation, including your net worth, including assets and liabilities, your personal credit score and business credit score. These will all determine what kind of financing you qualify for.
Knowing your net worth will also help you determine how much of your own cash you want to keep in reserve or invest directly in the business. Typically you don’t want to invest more than three quarters of your cash on hand in a new franchise.
You’ll also need to consider the full cost of the franchise, which is usually covered in your business plan. Beyond the franchise agreement, you’ll need to factor in location costs like rent or a mortgage, any equipment and inventory, employee pay and training, and marketing.
Make sure you research several franchise financing options. Many franchisors will offer loan options to help encourage you to get started, but they may not have the best terms.
How to Qualify for Franchise Financing
Once you’ve determined the type of financing you’re looking for and the lender you want to work with, you’ll need to complete a loan application and go through the lender’s application process. The documentation required will depend on the type of financing you’re trying to get.
It’s very likely there will be a personal credit check. With many types of financing, a good credit score will be helpful in qualifying for the best financing terms. This is certainly true of bank loans and SBA loans, but many other franchise financing options will involve a credit check as well. If you have business partners, each owner may have to agree to a credit check so make sure you are upfront with each other about any credit problems that may make it difficult to qualify.
You can also expect to provide information about the franchise you are purchasing and you may be required to provide financial projections. (Exact requirements vary depending on the type of financing involved.) Make sure you work with an experienced small business advisor or accounting professional as soon as possible.
Can I Buy a Franchise with No Money Down?
It may be possible to buy certain franchises with no upfront payment but if you are able to do so, it will likely be because you have stellar credit and other solid qualifications. You may have to pledge assets such as home equity as collateral. And you are not likely to be able to buy into the best franchises without some kind of down payment.
However, the reality is that most franchisees invest some money into their business, whether that’s from savings or from loans or investments from friends and family. It usually takes time for a new business to start generating enough profit to pay expenses and the owner’s salary; make sure you have some kind of cushion so you can survive financially during the first months or years.
Some of the best small business loans might not be in the obvious places, so don’t think you need to take the first loan offer that is a “Yes”—or accept the first “No.” Check out our business financing options guide to see some of your options. You might also want to look into one of the many small business grants available. Your franchise wouldn’t be the first to get startup capital that way.