Options for financing the purchase of a franchise are as varied as the franchise opportunities themselves. Your timeline, risk tolerance, credit history, and other factors will determine the best option for you. Let’s take a look at a few common sources of franchise financing.
Small Business and Franchise Financing Options
Franchise financing sources include:
- Cash
- Home equity lines of credit
- Bank or credit union loan
- SBA loan
- Equity financing
- Retirement accounts
- Franchisor financing
- Partners/friends/family
- Credit cards
- Online lenders
Saving and Using Cash
Do you have sufficient liquid or semi-liquid assets (e.g., cash, stocks, home equity, etc.) to run your business until you break even? If so, consider self-financing the purchase. Make sure to compare the “opportunity cost” of tying up your capital with the “hard cost” of accessing another type of financing instead, which will require monthly payments and interest rates.
If you don’t have adequate funding but hope to have it in the future, start preparing today. Maximize your savings and build your net worth and asset base. Set up a “business ownership” account at your bank. Then commit yourself to depositing a fixed amount of at least $500 into this account from each monthly paycheck. You can even set up a direct deposit to ensure consistency and remove the temptation to skip a deposit now and then. Most importantly, don’t touch any of these funds until you’re ready to invest in a business of your own.
You’ll be surprised at how quickly the money will grow. And your commitment will show potential funding sources that you’re serious about owning a franchise. After as little as six months to one year of following this savings plan, you will have a nice nest egg.
Then you can check with franchisors directly or contact a FranChoice consultant to explore your financing options.
Bank Business Lines of Credit
The easiest way to borrow money is to establish lines of credit or a business loan at a bank, and they’re one of the most conventional loans available for those looking to invest in a new business or franchise. You’ll need to have sufficient personal collateral, usually equity in your home, to secure a loan for the purchase of a business, along with a good credit score and detailed business plan. Collateral enables the bank to recoup its loss if you default on the business loan. Putting your personal collateral on the line for a business loan also shows the bank that you’ll work hard to protect your own investment and theirs.
Banks, savings and loans, and commercial finance companies are all potential lending sources for a business line of credit. Loans from these sources are called debt equity.
Small Business Administration (SBA) Loans
The U.S. Small Business Administration (SBA) also provides funding options.
For franchising, one of the most financing solutions from them is their SBA 7(a) loan program.
The SBA 7(a) loans are partially guaranteed by the SBA, meaning it makes it easier for SBA preferred lenders and financial institutions to support potential small business owners. The benefits of these SBA loans are the broad applications the funds can be used for, including working capital, equipment, buying commercial real estate, and more, along with their competitive interest rates and long repayment terms. Because of its broad benefits, it’s also known as a working capital loan. Its website provides information as well as advice on how to write a loan proposal.
If you decide to borrow money, keep in mind that the lender will require you to pay cash for a part of your business start-up costs (usually 25-50%).
The Small Business Investment Company Program (SBIC) is another financial assistance program available through the SBA. “SBICs” are privately owned and managed investment funds, licensed and regulated by the SBA. SBICs use their own capital plus funds borrowed with an SBA guarantee to make equity and debt investments in qualifying small businesses.
The other major SBA loan option that is used for franchise funding is the SBA CDC/504 loan. Unlike the broad type 7(a) loan, the SBA 504 loan is focused on major assets. SBA CDC/504 loans are often used by franchises to help new franchisees with machinery or equipment financing, or even for purchasing real estate or financing remodeling projects. SBA CDC/504 loans have a maximum loan amount of $5,500,000 and terms that can be up to 300 months long. For these business loans, interest rates are variable and tied to 10-year U.S. Treasury bonds, although they are typically no more than 3.0% of the total loan amount.
Equity Financing
Equity financing involves selling an ownership interest in your business in exchange for capital. Investors may be friends, relatives, or employees. Or, you can pursue what’s known as “venture capital” from a professional investor. Attracting venture capital for the purchase of a franchise may be challenging, however. Venture capitalists tend to favor companies that have earning potential exceeding that of a typical franchise unit.
Retirement Accounts
You may be able to access funds from your IRA, 401 (k), or other retirement savings account to invest in a business. Known as a ROBS (Rollover as Business Startups), or 401(k) business financing, this small business funding structure is similar to buying stock in a public company, except you’re investing in your own privately held company. The process starts with having a retirement account that can invest in a new company, which is why most choose a 401(k) plan, and the common name is also 401(k) business financing. You will then deposit your retirement funds in this new account.
Your 401(k) business financing retirement account will then proceed to invest directly in your new franchise and startup costs (franchise fees, capital requirements, etc), and take ownership by purchasing stock in the corporation. There are no early withdrawal penalties or upfront taxes. And the percentage of profits corresponding to your retirement account’s ownership can be redeposited. This franchise financing method is very specialized, so it’s important to consult an experienced professional. Wanna know if this will work for you? Find out here.
Franchisor Financing
One of the great advantages of franchised businesses is their track record. In many cases, the franchisor leverages this track record to set up financing programs for new franchisees.
These franchisor-assisted financial programs can be leases or loans and are awarded primarily due to the success of the franchise system rather than the creditworthiness of the individual borrower. If you’re interested in this franchise loan option, gather information from the franchisor during your research and investigation.
Partners, Friends, and Relatives
Friends and relatives who have confidence in your entrepreneurial abilities may be willing to loan you money as you begin your business venture. You may also want to look for a partner to help you finance and run the business, especially if you lack business skills or experience. We’ve seen great results when partners complement each other, for example, when one is a dynamic cold caller and the other excels at handling the employee and customer service aspects.
Determining franchise financing is one of the most critical choices you’ll have as a new owner. It’s wise to thoroughly investigate your options and consult with appropriate professionals. Don’t forget that your franchisor is a great resource for information.