Opening your own franchise is a smart decision if you’re an ambitious entrepreneur. Being the owner of a franchise offers the flexibility to be your own boss, yet with the security of owning an already established brand. Like with any business, though, the costs of starting up can be pretty high and you might need a loan for franchises. And with the world still feeling the effects of COVID-19, securing financing for a small business could prove difficult.
Aside from normal business startup costs, a franchisee also pays other fees, such as a franchise fee and royalty fees for the use of the franchise name. You need good business sense, a solid plan, ample cash flow and franchise financing.
What is franchise financing?
Lots of people want to own their own business, but not many have $100,000 or more set aside to bring that dream to fruition.
Franchise financing can be used for:
- Opening a new franchise
- Buying an established franchise
- Keeping an existing franchise in operation
The majority of franchisees must obtain a business loan at some time. Usually, franchisees have a much easier time obtaining bank or Small Business Administration (SBA) financing in comparison with other small business owners.
But even franchisees aren’t a shoo-in—applications and approval processes can be quite long, especially if you need capital right now. Some franchisors may offer a financing program, but this isn’t a widespread practice. Relying on your franchisor for funding isn’t 100 percent a given.
This is causing a lot of franchisees to turn to alternative lending for financing. An online lender is usually much more lenient on borrowers. They can also get your funds to you in much less time than a traditional bank loan; sometimes in as little as a week after receiving your funding application.
The following is a list of the best small business financing loans for franchises. Their order doesn’t necessarily convey their ranking. Your best choice for franchise funding depends on your specific requirements.
Why do franchises need financing?
Franchising offers many different options to entrepreneurs. Business costs vary, and so do franchises. Your specific costs depend on the type of business the franchise operates and whether you need to carry cash reserves. Some franchises have startup fees around $10,000, others, as high as $5 million. If you’re opening a home-based franchise, your costs will be on the lower end, while a hotel franchise might be closer to the other end of the spectrum.
Common reasons to seek financing
In addition to the usual startup fees, you’ll also have professional costs, such as:
- Attorney fees for reviewing your contract.
- An accountant to help you make sense of the numbers.
- Contractor costs if you have to build your own building.
- Rental fees if you’re renting office or store space.
The attorney and accountant fees play a role, even if you’re running a home-based business.
Other fees you may run into include:
- Land maintenance
Since franchises usually have the same signage, landscaping and other details, many of these answers will be provided to you by the franchisor. Regardless, your costs of starting your business still accumulate on top of your franchise fee. Franchise fees can be between $20,000 and $30,000, and some are even higher, especially if they’re well-established and have a great reputation.
You’ll most likely need at least the equivalent of a couple of years’ working capital to ensure you get your franchise off the ground. Experienced franchisees state about two years’ worth will suffice. But you still have to monitor every single purchase because even with two years’ worth of money in the bank, it’s not unheard of for new franchisees to run out of capital.
The best loans for franchises
Some of the best loans for franchises available to consider, and in no particular order, include:
- SBA loans
- Term loans
- Lines of credit
- Merchant cash advance
- Business credit card
- Traditional bank loan
After reviewing the types of loans available for franchises, you’ll need to choose a lender.
Choosing a lender
Choosing your lender is a critical decision in your financing journey. There are two types of lenders: direct private lenders and marketplace lenders.
Direct private lender
A direct private lender issues loans with their own funds and doesn’t rely on depositors and investors. Direct private lenders are normally much more flexible in their approvals. A direct private lender can offer a variety of loan types, such as asset-backed bridge loans or unsecured business loans. They can also offer you more money than other lenders. A direct lender may even offer lower-value loans that a more traditional financial institution wouldn’t consider.
A marketplace, or peer-to-peer, lender leverages technological platforms to circumvent the traditional bank route, connecting borrowers with the investors they need directly. Banks lend deposited money, whereas a marketplace lender packages multiple investor loans and delivers the money to its borrowers. The marketplace collects commissions and/or fees in return for the service. Marketplace lenders generally use the borrower’s credit score in making their lending decision.
How to apply for franchise financing
As with all business loans, franchise loans are usually specific to your franchise type and your chosen lender. For instance, if you opt for an SBA or traditional bank loan, the application process is lengthy and requires significant documentation. If you choose an online lender, the application process is much shorter, and you can submit your documents online.
Regardless, there are a few requirements you’re expected to meet independently of the exact application, such as:
- Personal credit history
- Financial information
- Business plan
Let’s look at these in greater detail.
Personal credit history
Your personal credit history is the number one item a lender considers when you need a loan for a franchise. Your credit score shows your reliability regarding personal and business debt responsibility. If you don’t have any credit or your credit history is less than perfect, some lenders may still work with you, but it drastically cuts your chances of approval. That said, you could qualify for a business loan for bad credit. If your business has suffered due to the pandemic, you aren’t out of the race just yet—you could still see success.
Before applying for franchise loans, it’s important to take a look at your credit score and history. If you find unusual or incorrect information, you must resolve those prior to submitting a franchise loan application.
Then, before diving deep in the waters of loan applications, organize your financial paperwork, both personal- and business-oriented. Lenders typically use your financial information to establish your unique financial situation, your likelihood of repayment and how long repayment should take.
Prepare to furnish the following at a minimum:
- Banking statements
- Business balance sheets and/or income statements
- Personal tax return
- Business tax return (if any)
- Debt schedule, if you carry any personal or business debt
- Business plan
While not every lender requires a business plan, this may be a significant requirement for a franchise loan.
Your business plan should outline the company you’d like to franchise with, how you’re planning to do so and how you plan to use the funding to start or expand the franchise business.
Overall, a lender usually favors franchises that have household, recognizable names. If your franchise isn’t well known, you may find qualifying for a franchise loan difficult. This doesn’t mean it’s impossible, but it means strengthening your application is paramount. Some ways you can beef up your franchise loan application include solid financial reporting, a good credit history and a resume of other, related business experience.
Franchise financing final thoughts
Starting or expanding franchises isn’t easy, but knowing the various funding options available and how you can apply puts you in the best position to access it. Whether you opt for a small business line of credit (or a revolving line of credit), an SBA loan or a short-term loan for a franchise, your next steps include preparing and submitting your application. Check here if you’re curious about how small business loans work.
Be sure you work with your lender closely to understand every expectation. This speeds up the process by completing and submitting accurate information and increases your approval odds. And your future successes depend on it.