Franchise Financing Tips

Below is a step-by-step process to follow when considering financing for a franchise:

First, prepare a personal financial statement for yourself (and any others joining you in your venture). The SBA version is available on the agency’s Web site  under Tools/Financial Assistance Forms (No. 413) Personal Financial Assistance.

Once you have completed the statement, take a look on the asset side and look at the funds that you have available. Decide on your personal level of risk, and how much of your resources you are willing to invest in your franchise. Next, create a strategic plan for your business.

Sources of capital for financing a franchise include:

  • Cash,
  • Conventional loans,
  • Self-directed retirement plans,
  • Leasing,
  • Direct franchisor financing and,
  • SBA Loans/Patriot Express Loans

Of course, using your own cash to buy the franchise will create a debt-free business. However, if you are looking at becoming an operator of more than one unit-known as a multi-unit operator, that may not be the best strategy since you will need your cash for growth. Your plan, along with Item 5 in the franchise system’s Franchise Disclosure Documen,t should give you some direction. If you are utilizing an “angel” investor (friends, family or even crowd funding through the Internet), be sure to closely document in writing the business terms. Otherwise, there may be issues later when things need to be discussed.

Conventional Loans
Conventional loans are usually limited to existing business owners seeking unit expansion, or new owners with very specific direct experience. In addition, lenders are looking for collateral in real estate that can be attached to mitigate their risk. Terms generally run from five to 10 years.

Self Directed Retirement Plans
You may be able to use your 401(k) or IRA as your partner in your franchise. There are some specific requirements, and the process takes only a couple of weeks to get completed. There is a very strict process that needs to be followed, and you should engage an expert in the field to help you get started. Visit the IFA Web site to locate members of the association’s Supplier Forum who support VetFran and specialize in this process.

If your franchise has hard assets or equipment, such as vehicles, office machinery, etc., leasing may be your best option. Rates and terms vary widely, so you need to do research on your equipment package, and the best way to finance it.

Direct Franchisor Financing
Most franchisors do not offer financing. Item 10 of the disclosure document will state whether financing is offered. If financing is available, it may not be at the best terms that you may qualify for on your own, so make sure that you do due diligence for yourself.

SBA Loans
SBA loans provide one of the most common forms of financing for a franchise. These loans are designed to mitigate lenders’ risk by offering a guarantee on the principal of the loan from the U.S. government. If real estate is involved, the government actually funds a portion of the loan directly. The SBA loan application process can be cumbersome. SBA loans require personal guarantees from you and your spouse and almost always require a mortgage to be placed on your primary residence, as well as your other properties. Make sure that you get professional help when applying for an SBA loan. Your franchisor may recommend someone, or you can engage your CPA’s assistance.

Here again, there are IFA Supplier Forum members that specialize in placing SBA loans that can be located via the association’s Web site.

Patriot Express Loans
SBA recently began offering these loans to military families to establish or expand a small business. Eligible military community members include:

  • Veterans,
  • Service-disabled veterans,
  • Active-duty service members eligible for the military’s Transition Assistance Program,
  • Reservists and National Guard members,
  • Current spouses of any of the above, and
  • The widowed spouse of a service member or veteran who died during service or of a service-connected disability.

Patriot Express Loans may offer a lower down payment than regular SBA loans, but also can carry a much higher interest rate, sometimes as high as the prime rate plus 4.75 percent, whereas SBA 7(a) loans are capped at prime-plus 2.75 percent. These are probably not the best product for you if you have the capital available to use as a down payment. Having 85 percent leverage (loan to value) is also a greater risk.

While it is great to have the option of the Patriot Express Loan, you should determine whether or not you are eligible for an ordinary SBA loan before proceeding with some of the financing terms of a Patriot Express Loan.

Explore All Options
A combination of some or all of the funding vehicles mentioned above may be best for the funding of your franchise. Don’t rely on only one method. Explore all that apply to your concept, your financial situation, and your risk tolerance. Use the resources that IFA makes available through its Web site, and enlist the expertise of IFA’s Supplier Forum to help you get through this process. Financing is much more of a challenge today than it was in the past. Don’t give up after only one or two tries. Persistence will pay off.