This article was reviewed and updated on August 10, 2020
If you’ve decided to join the millions of business owners who own a franchise, 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, buy 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.
Six Ways to Finance a Franchise
1. Franchisor Financing
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 financing 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. Bank financing tends to require substantial documentation. The owner’s personal credit rating, as well as any business credit rating, will be scrutinized. Traditional financial institutions tend to be fairly conservative, so if you’re purchasing a 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 owner put up collateral; you may have to pledge equity in your home, if you don’t have business assets that can be pledged. 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.
3. SBA Loan
Loans guaranteed by the Small Business Administration (SBA) offer attractive rates and 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. Not surprisingly, these loans do require a fairly extensive application process and the applicant should have good credit and contribute funds toward the purchase.
There are several types of SBA loans. The 7(a) loan program is one of the most popular for franchise financing. 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 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.)
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 often 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. 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.
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 you franchise fee. The franchise feee 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.
How to Apply 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 an application and go through the lender’s creditworthiness evaluation. It’s likely that along with your business credit, your personal credit history will be part of the equation. What’s more, the franchisor (depending on the franchise) will likely also be looking at your personal credit history.
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.