The Complete Guide to Franchise Funding
Starting a business from scratch is a highly challenging endeavor, yet building a recognizable brand from nothing is even more difficult. Running a franchise gives you access to a known brand’s trademarks, knowledge, processes, and name.
Brands from fast food to pest control have jumped into the franchising industry to expand their reach and boost their profiles rapidly. In fact, it’s estimated that the U.S. has 750,000 franchise businesses alone.
Today, we’re going to discuss how franchise business loans work and how to get a franchise loan.
What are Franchise Loans?
Franchises can do a lot for anyone who wants to start a new venture under their banner, but it’s crucial to develop a plan for financing a franchise.
The initial cost is paying the startup and licensing fee. These charges depend on the franchise, with more prominent brand names, such as McDonald’s, charging more than those who haven’t been in the business for long.
Franchise costs can range from a few thousand dollars to a few million dollars. Beyond the initial startup fees, you’ll likely have to pay ongoing fees to maintain control of your franchise. Entrepreneurs with little starting capital can obtain specialized franchise financing to cover these costs.
These loans work in much the same way as any other loan. You receive a lump sum and make regular monthly repayments until you’ve paid the loan off. These loans may be used for any associated business expenses.
Generally, financing a franchise will require you to put up at least 10-30% of the money from your personal funds. Lenders want to see that you’ve got some skin in the game.
Common Costs of Running a Franchise
With few limits on what you can spend the money on, what are the typical costs you’ll likely encounter when running a franchise?
Franchises put strict limits on business location, activities, prices, etc. Before committing to any one franchise, you’ll be able to receive an estimate on your build-out costs.
- Franchise Fees – Franchising fees are the largest cost you incur during your first year. These commonly cost tens of thousands of dollars because you’re essentially renting the brand. A loan for a franchise can cover these fees and may also cover any ongoing license fees.
- Build–Out Costs – Your build-out costs will vary depending on your business. For example, a mobile hotdog van or a pest control business will see few build-out costs. A new fast food outlet, on the other hand, will require all the equipment, fixtures, and fittings.
- Working Capital – Most franchises will also provide detailed information on the amount of working capital required to keep your new business moving. A franchise loan can ensure you have the liquidity to maintain your business’s activities.
- Supplies – Your basic supplies will be a regular ongoing cost. Again, the supplies and their cost will vary depending on the business. For example, a restaurant will need food, plates, cutlery, and napkins.
- Inventory – Franchises will often stipulate a minimum amount of inventory to get started. Running a store may mean spending anything from $20,000 to $150,000 in stock to get moving.
As you can see, the costs of running a franchise go well beyond the franchising fees themselves. You’ll need a considerable amount of franchise funding to start all but the most minor franchises.
These are only a basic overview of costs. More formalized franchising programs may even require you to attend a training camp, which, again, can lead to you incurring travel and living expenses.
Types of Franchise Financing
There are lots of franchise funding options available, which means you need to weigh up your options and consider whether they fit your business plan. The right franchise loan can make your business, and the wrong one can break it. It’s essential to consider several options for franchise funds first.
Here are the main types of financing available to you.
U.S. Small Business Administration (SBA) Loans
SBA franchise loans cover up to 85% of a business’s loan amount. These loans are designed for small businesses to get off the ground. Although the SBA doesn’t offer financing itself, it works with banks, credit unions, and other lenders across the nation. They guarantee the loan, so lenders are more willing to support small business owners.
The security offered to borrowers and lenders is beneficial for both parties, making SBA franchise loans among the most helpful loan types in the country.
The best part is that you only need a minimum 500 FICO score, which is considerably lower than other lenders. You can also lend anything from $30,000 to $5,000,000. With no minimum monthly revenue requirements and payback periods up to 25 years, you’ve already got your business off on the right foot if you can obtain an SBA loan.
Startup Business Loans
Unfortunately, your franchise financing options are considerably more limited when starting a business from nothing. Startup business loans are an option if you’re searching for alternatives to fund your franchise.
Startup business loans are designed for those who have never owned a business before. They also offer super low-interest rates. Your existing FICO score will determine whether you’re eligible for financing.
Most lenders request a minimum of 680 on your credit score before they’ll consider lending. If you’ve got a poor credit score, you’ll need to work on building it up first.
Some of the larger franchises may even offer their own financing departments. It makes sense from a financial standpoint because when franchise businesses pay interest rates and other fees under their banner, they create a recurring stream of income.
Franchisors that offer this service are free to divine whatever terms they like, so make sure you read through their terms and conditions carefully. Some offers of financing are better than others.
Different franchises will also have varying requirements. Some are more stringent regarding previous business experience and credit scores than traditional lenders. Read their Franchise Disclosure Document and study the brand before committing to anything.
Business Credit Cards
Taking out a business credit card will not enable you to cover the higher costs of doing business, but it can cover your smaller obligations.
For example, many businesses often put their supplies and some of their inventory on a business credit card to tide them over until the end of the month.
You’ll be able to obtain a business credit card when opening up your business bank account. Again, do your research and compare different business credit card offers.
How to Get a Franchise Funding
Securing a franchise loan doesn’t differ that much from any other form of financing. Applying for franchise financing is a matter of finding the right lender and sending them a strong application.
The basic steps for obtaining one of these franchise funding loans include:
- Step One – Compare and contrast different funding options. You need the loan that best suits your new business. It’s always better to borrow less from the right lender than to borrow more from the wrong lender.
- Step Two – Check the lender’s requirements. Make sure you meet those requirements before applying to avoid wasting your time. Many lenders use automated verification systems, so if you don’t meet the requirements, your application will never even be seen by a human.
- Step Three – Submit your business plan. You obviously don’t have any current business accounts if you’re just getting started. Instead, you should have a comprehensive business plan explaining your franchise proposition and how you will grow that franchise.
- Step Four – Wait for the lender to get back to you. Depending on which financing option you choose, this could be a few days or a few weeks. Be patient, and don’t be afraid to examine other options in the meantime.
- Step Five – Get your money. If approved, you’ll likely receive the funds in your account within a few business days. If rejected, start the process again. Just because one lender didn’t approve you doesn’t mean another lender won’t.
Unlocking franchise funding is often the biggest hurdle entrepreneurs need to overcome. Be patient and be persistent. If you’re struggling to capture the interest of any lenders, you may need to work on your shortcomings as a prospective borrower and revisit once you’ve made some changes.
Tips for Getting Approved for a Franchise Loan
A loan for a franchise can launch your business and propel your career. Unfortunately, not everyone is an ideal candidate – at least initially.
Follow these tips to increase your chances of getting approved for a franchise loan.
Build Your Credit Score
Starting a new business means you don’t have a business credit score to fall back on. Instead, lenders will use your personal credit score to deduce your creditworthiness. Most lenders have minimum credit requirements, so make sure you obtain a free copy of your credit report first to find out where you lie.
So, what are some top tips for building your credit score?
- Reduce your debt load
- Improve your credit ratio
- Make regular repayments on time
In many cases, taking out a credit card and making small purchases can build your score in the long term. If you have a poor credit score, this is an endeavor that could take months. Be patient and practice good credit habits until you meet the lender’s requirements.
Refine Your Business Plan
Lenders will want to see a copy of your business plan. It’s not just a roadmap for growth, but demonstrates your experience and commitment as a business owner.
The biggest mistake you can make is not being detailed enough in your business plan, with the second error being overstating your potential profits. Keep your plan modest and grounded in reality.
Increase Your Personal Capital
Lenders will seldom issue a significant loan for a new franchise business with no money down. It enhances the risk for the lender and, in theory, makes founders less motivated because they don’t have any personal financial stake in the business.
One way to get around constant rejection is to increase the personal capital you’re willing to put down. A few extra thousand dollars demonstrates to lenders that you’re serious about making your new franchise operation successful.
Get a Co-Applicant
Some lenders may also accent co-applicants on a loan application. A co-applicant is a guarantor of the loan, so if you fail to make the repayments, they will be on the hook to cover the loan. Think carefully about taking on a co-guarantor, as not every lender will accept them, and it can be tough to find a reliable one.
Start with a friend or family member and go from there.
Secure Franchise Funding with L3
Building a successful franchise requires hard work, time and dedication. Enlist the help of experienced professionals and have financial experts on your side. At L3 Funding, we specialize in supporting America’s small business community through intelligent resources, support, and financing options.
To learn more about merchant funding, contact L3 today.