Franchise Lending: How It Works

The main advantage of a franchise is hard to overlook: they combine the flexibility and independence of small business ownership with the infrastructure, reach, and support of a large corporation. In many ways, it offers the best of both worlds.

Because many franchises offer access to a proven business model, startup fees and costs can often be significant for the franchisee. Thankfully, there are some funding options available if you’re interested specifically in obtaining franchise lending!

Let’s take a closer look at the most popular paths for financing a new franchise.

Securing a Commercial Bank Loan for Franchise Lending

Many aspiring franchisees begin their funding search at a commercial bank. Before making a pitch to a bank lender, though, it’s important to get your financial ducks in a row. Your credit rating is one of the most important parts of your loan application, so it’s a good idea to pay down debt and take other credit score improvement steps in the months before you make your bid.

You’ll also need to create a personal financial statement, gather tax records going back several years and, in most cases, verify the source of your down payment. In this way, preparing for a franchise loan is sort of similar to preparing for a mortgage. There’s one major difference, though: creditworthiness is only part of the game in franchise lending. You’ll also get evaluated on the strength of your business plan. Because of this, opting for a franchise over an independent new startup might work in your favor, since traditional banks tend to favor enterprises with proven track records and established market presence.

You could also be quizzed about your work history, background, income, and overall business track record. Healthy personal finances and a record of sustained business success make you a strong candidate for a franchise loan in the eyes of lenders. On the other hand, if you can’t manage your household budget, lenders might be skeptical that you can successfully manage the finances of a much larger operation.

Franchise Lending from the Franchisor

Seeking financing directly from a franchisor is one of the most common ways for new franchisees to get funding. This approach has a couple of benefits. First, it’s a streamlined “one-stop-shop” that lets you get up and running as quickly as possible. Second, franchisors can also help you secure loans for equipment or other costs outside the standalone franchise fee.

Franchisor loans come in a bunch of different forms. Some are based on simple interest with no principal, some offer zero-percent financing for a limited time, and others might offer deferred payments for a prescribed period of time. The rates offered through franchisor funding can vary pretty considerably. Some franchisors finance internally, while others work with third-party lenders to secure financing for franchisees. Some of the most well-known companies offering franchisor funding include Meineke, The UPS Store, and Gold’s Gym.

Franchise Lending Through the SBA

Securing a loan through the Small Business Association (SBA) is another popular way to finance a franchise purchase. These loans are generally considered to be lower risk by lenders because they’re partially guaranteed by the federal government. About 10% of all SBA loans are categorized as franchise lending and the SBA will lend up to $2 million, provided that the borrower meets credit requirements and contributes some equity.

While the rates on many SBA loans fluctuate, the federal government caps them at a maximum percentage point that’s tied to the prime rate. This keeps the SBA loan market competitive while also helping borrowers who might otherwise have a hard time securing financing without the government’s guarantee.

Alternative Franchise Lending

While there are considerable differences between traditional bank loans, franchisor loans, and SBA lending, they all require two things: lots of documentation and significant creditworthiness. Unfortunately, not everyone can meet those sometimes exacting requirements.

But there are other franchise lending avenues you can pursue. Lining up friends and family members as potential investors is one tried-and-true way to raise capital. Finding a partner or an early-stage investor is another.

There are also alternative lenders that specialize in serving aspiring franchise owners who don’t have the time or financial standing to work with more traditional institutions. These lenders usually charge a higher interest rate, but their qualification process is easier and faster by a mile.

For example, the SBA loan application process often takes months, requiring tax returns, financial histories, and profit and loss statements—not to mention collateral. Alternative lenders can offer funding in weeks, if not days or even hours, and sometimes deal in loans with no collateral demands.

While alternative lending currently only represents about 4% of the $30 billion loaned to franchisees every year, it’s a rapidly growing model set to snag a much larger share of the franchise lending pie in the years ahead.

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Investing in a franchise lets small business owners leverage the benefits of larger, well-established companies—for a fee, of course. And commercial bank funding, SBA loans, franchisor financing, and alternative lending are all popular ways to fund a new franchise.

If you’re considering starting up a franchise, put yourself in the best possible position to succeed by taking the time to determine which funding option is the right choice for you.

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from Fundera Ledger https://www.fundera.com/blog/2016/02/10/franchise-lending/