In 2017, there were almost 750,000 franchises operating in the United States. There are any number of great franchise businesses out there, and if you have a background or expertise in a particular area, in anything from food trucks to florists, opening a franchise could be a great way for you to become a business owner.
When you open a franchise, your business benefits from the structure, experience and support of corporate backing. But you get to be independent and creative, tailoring your business to a particular area and customer.
Purchasing a franchise typically requires a large investment. You not only have standard start up costs, but there’s also a franchise fee to cover before you can open the doors to your business. For most franchise owners, that means finding a way to finance the purchase.
What is franchise financing?
Franchise financing is type of commercial loan that takes into account the kind of business you are buying and can offer terms particular to a franchise purchase, including accounting for the cost of a franchise fee.
For many banks, financing a franchise purchase is a safer bet than another type of business since the bank knows you’ll have some benefits that other business don’t have, including, brand recognition and support from the larger brand.
Another benefit for this type of loan for a bank is that often, purchasing a franchise means a built in business plan in addition to marketing and information about any specialized equipment you might need.
Those are important parts of a business that independent owners can struggle with and having franchise backing can alleviate those potential pain points.
Alternatively, some franchises, including the UPS Store and Popeye’s restaurants, offer financing support to purchasers. This can be a way to get at least part of your franchise purchase costs covered.
How do you qualify for a franchise loan?
Like any other kind of loan, franchise loans require a bank application that discloses financial information including debts and assets, business experience, credit history and a personal credit score. The bank or lender will evaluate you as a borrower based on this information, and then determine the amount of money it can lend you, under what terms, to open your business.
Can I get a franchise loan with bad credit?
The short answer is, it depends. According to Chris Wooldridge, a professor of Economics and Finance at Murray State University, and the Director of the Kentucky Small Business Development Center there, banks are going to look for a minimum score of 660.
Small Business Association, or SBA loans, require a credit score of 640. Some online lenders may offer more flexibility for lower credit scores. Those loans, however, are often offered for shorter terms at higher interest rates.
Also, cautions Wooldridge, keep in mind that there are regulatory requirements that banks must follow, so if you find an online loan and you have a credit score less than 640 or so, proceed with caution.
Can you open a franchise with no money?
While not ideal, it’s also not unheard of to open a franchise without any cash on hand. There are financing options that involve borrowing using home equity or against a retirement fund, but that can be a big financial risk.
You might also be able to find a business partner who would provide startup cash in exchange for your investment of time in the business.
Lastly, you may have collateral that you haven’t thought of that could support your loan. For example, Wooldridge cites a loan that was granted using gold bars as security against the amount borrowed.
Keep in mind that depending on the type of collateral you have to offer, a bank will be able to offer you more or less money. For example, according to Wooldridge, you can probably borrow about 80% against the value of real estate.
“It’s not going anywhere,” he explained.
But for other assets, including specific business equipment that depreciates over time, or other inventory, banks may only offer you 50% of the value of the asset.
Financing without cash can be tricky. The bottom line is that when considering a franchise loan, “you should be prepared to put at least 20% of your own cash or equity down,” explained Wooldridge.
How to find the best franchise loan for your needs
Business loans for franchises are structured differently than other types of loans, like a mortgage.
“Let’s say you want a $1,000,000 loan” to open your business, suggested Wooldridge.
“That buys a lot of stuff: a building and land, equipment and inventory. Let’s assume it’s $500,000 worth of real estate, $250,000 of equipment and $250,000 of inventory (which is a lot!).”
“All three of those are going to be looked at differently” by a bank, he explained.
In his scenario, since the risk level for real estate is pretty low, a bank might offer a 20 year loan between four and six percent, variable.
Since equipment is “way more risky than real estate--it can break, it can become out of date--the bank might offer a seven year term at 10% fixed rate, though it could be variable.”
Your last 25% of a financing package might be in a line of credit to support inventory purchases and cash flow. “It’s a working asset, on which interest is paid monthly, and the principal is paid when you sell inventory,” he said. Since it’s a line of credit, you can pay back principal and then borrow again if you need to, up unto the limit of your credit line.
As a potential owner, and borrower, you’ll want to evaluate the terms of each loan to find the best package for your particular situation.
How to Apply for a Franchise Loan
Before opening a business of any kind, Wooldridge recommends assembling a team of advisors. Because even if you have years of experience in a business or background knowledge about an industry, no small business owner can account for every possibility.
His list of recommended advisors includes:
- A banker: Someone who can help you think about the amount of debt you can take on and pay back in a reasonable amount of time.
- An insurance agent: Someone who can serve as a risk manager and help an owner identity where there are risks and insure against them.
- An attorney: Someone who can help you set up a corporation. And then, later, in the event that you’re sued, an attorney can help with a legal strategy if you need one.
- An accountant: Even though most new businesses can't afford a dedicated accountant, they can help you start thinking about tax liability and how to handle taxes.
Once you have a team of advisors in place, it’s time to approach a lender and submit a loan application. Then, it’s time to consider the terms yourself and with your team of advisors. Once the funding is in place, you’re ready to join those 750,000 owners in a franchise business.