Franchise ownership is an ideal way to make the leap to being a business owner. The great thing about becoming part of a franchise system is that your leap comes with the support and guidance of an established business.
But, if you’re considering this path, you must think about the financing option that is right for you. There are many choices and avenues that will need to be evaluated before you can make a decision. One exciting thing about exploring franchise ownership though is it’s often easier to obtain financing as a franchisee than as a new, independent business owner.
In general, lenders like to see franchisees who can fulfill the 5 C’s: capital, credit, capacity, character and collateral. The ideal borrower will have liquid cash for a down payment, a strong credit history, enough cash flow to cover paying back debts, prior experience in the industry their business is in, and personal property they can use to guarantee the loan (usually a home).
Most franchisees bankroll their franchise through some form of self-financing. This can mean a home equity loan, a second mortgage, using money from savings or even withdrawing funds from your retirement account. Here are some of the most popular bank loan options for you as a potential franchisee.
- Rollover for Business Startups (ROBS)– ROBS allows you to use money in your retirement accounts (either a 401(k), traditional IRA or another eligible retirement account) and invest that money in your franchise. The advantage of this option is you do not have to pay taxes or an early withdrawal penalty for removing these funds. With that said, it is not a process that is simple, you will need the help of an experienced attorney and CPA and will need to work with a company that specializes in ROBS transactions.
Funding your franchise via ROBS is often a good indicator of success. A study conducted by Guidant Financial found that 81 percent of business owners that funded their startup this way were still in business four years later. Meanwhile only 39 percent of those surveyed who funded their business with a traditional business loan were still operating.
- Small Business Administration Loans (SBA) – SBA loansare government-guaranteed loans. They are a great choice for financing your franchise dream because they offer long repayment terms and low interest rates. However, qualifying for one of these loans requires a solid financial history, including a good credit score (something higher than 650), as well as collateral and a 10 to 20 percent down payment.
- Home Equity Loan or Line of Credit/Second Mortgage– This is an option for homeowners who have equity in their homes. You can borrow against this equity to help finance your franchise. The rates for a home equity loan generally range between 2 and 7 percent, depending on your credit score. The catch is if you have issues repaying the loan, your home is on the line.
Increasing Your Odds of Qualifying for a Franchise Loan
If you are opting to go the bank loan route to finance your dream of owning your own franchise, there are some things you can do to improve your chances. To start with, be sure you have already determined the franchise you want to pursue. The lender will be interested in information such as the potential location of your franchise, as well as historical performance and startup and operating costs, information that you won’t have if you haven’t already determined which franchise company you will be purchasing.
Also, before you meet with a prospective lender, it’s a good idea to have your lawyer and your accountant to review the Franchise Disclosure Document (FDD), which will provide further details about the startup and operating costs.
Next, take the time to seek out and talk to existing franchisees in the network to get a feel for their experiences with the franchisor. Once you have made the decision about what franchise you are interested in, reviewed the FDD, and sought out franchisees in the system, here’s what you should do to increase your odds of qualifying with a lender for a loan:
- Create a Business Plan. Just because you are purchasing a franchise business versus starting your own company from scratch does not negate the importance of a business plan, particularly in the eyes of a potential lender or the SBA. Pay attention to the financial projections section, which the FDD will help you complete.
- Improve Your Personal Credit. Prior to talking to a lender, check out your credit score and see what you can do to boost your number. This can entail reducing the amount of credit you use, holding off on applying for any new credit cards that require a hard credit pull which can lower your score or even something as simple as ensuring you are paying all your bills on time.
- Gather Your Portion of the Collateral. Most lenders will require 10 to 20 percent down payment (more is always better), in addition to some form of collateral to show that you have a vested interest in the financial success of your future franchise.
Choosing the right financing is an essential step to the future success of owning your dream franchise. The time you spend upfront researching, evaluating and even adjusting your personal finances will be well worth it when you’re able realize the reward of your investment.