Financing a Franchise: 7 Best Loan Options for 2024
Franchise financing can provide the money you need to purchase a franchise. It can also cover working capital needs for day-to-day expenses such as rent, utilities, maintenance, inventory, payroll, and other business costs. You can get franchise financing from a wide range of sources. Each has differences with regard to things like rates, fees, and eligibility criteria, and some may also have restrictions on how you may use the funds.
Below is a list of seven ways of financing a franchise and who should consider each.
1. Franchisor Financing
Who It’s For & Where to Get It
Due to the ability to negotiate terms, getting financing directly through the franchisor can yield the best rates and terms. If you’re looking for guidance or expertise, franchisors may also have a network of preferred lenders who understand the nuances of the brand you’re buying into.
The exact steps to get this funding can vary depending on the franchisor, but you’ll be expected to review a Franchise Disclosure Document (FDD). This details various aspects of the franchise, such as initial & ongoing costs, advertising requirements, training details, dispute resolution, and more. You can visit the FTC’s Consumer’s Guide to Buying a Franchise to learn more about the sections in the FDD.
If your franchisor works with a network of lending partners, it can give you instructions on how to submit a separate loan application if needed.
To streamline the process, you can head to our guide on how to get a small business loan for commonly required documents and tips on how to get approved at the best rate available.
2. SBA Loans
Who It’s For & Where to Get It
SBA loans are government-backed loans issued by individual lenders. To be eligible, borrowers must typically have strong credit and finances. Loans may also take up to 90 or more days to fund, but in exchange, eligible borrowers can get some of the most competitive rates available.
The SBA offers different loan programs depending on how you intend to use the funds. For instance, the SBA 7(a) loan program allows for loan proceeds to be used on working capital, equipment, inventory, machinery, financing the costs to improve a building, and more. On the other hand, the SBA 504 loan program is useful for acquiring large fixed assets that play a role in generating jobs or business growth.
Check out our guide on how to get an SBA loan for specific advice on how to get this type of loan. We recommend working with a business loan broker like Lendio if you’re unsure where to start. It has a large network of providers it can match you with and also assigns a dedicated specialist to each borrower to ensure a high level of personalized service.
3. ROBS
Who It’s For & Where to Get It
A ROBS can be a good option for business owners who want access to their own retirement funds and do not want or are unable to get a business loan. Since a ROBS allows tax- and penalty-free access to your retirement account balances, it does not have the typical loan requirements.
Getting a ROBS completed is a complex process that can result in fines and penalties if done incorrectly. There are also ongoing compliance requirements that must be met. Read our ROBS guide for the steps involved with how you can get the process started and to learn more about whether this might be a good option for you.
If you’re interested in moving forward, you can work with a ROBS provider like Guidant Financial. It has a track record of completing these transactions in a fully compliant manner with IRS and other regulatory requirements. It also offers one of the industry’s best legal and audit support services.
4. Working Capital Loans
Who It’s For & Where to Get It
Working capital loans are a good choice if you need short-term financing to cover day-to-day business expenses. Some examples can include payroll, rent, utilities, and inventory. Many lenders also have flexibility in eligibility criteria, allowing newer businesses and those with lower credit scores to still qualify.
These loans can come in the form of a closed-end loan, where funds are issued in one lump sum. They can also come in the form of a line of credit, where you can draw funds on an as-needed basis up to your assigned credit limit.
If you’re unsure if a closed-end loan or line of credit is better, you can check out our guide on business lines of credit.
Bluevine is one provider we recommend for businesses seeking this type of loan. It offers a small business line of credit and made our list of the best working capital loans thanks to its competitive rates and ability to issue approvals quickly.
5. HELOAN or HELOC
Who It’s For & Where to Get It
Most HELOANs, including HELOCs, allow funds to be used for nearly any personal or business purpose. These loans can be worth considering for business owners who have sufficient equity in their personal residence, have good personal credit, and are unable to qualify for business financing.
HELOANs usually carry fixed interest rates and provide a single lump sum of funds that can be deposited into your bank account. HELOCs, by comparison, often have variable interest rates but allow you to continuously draw funds on an as-needed basis.
You can use LendingTree to find a lender as it can help you compare rates and terms among multiple lenders with just one application.
6. Personal Loan for Business Purposes
Who It’s For & Where to Get It
Consider a personal loan if you have good personal credit and income but do not meet the criteria for a business loan for things like revenue or time in business. Personal loans can also be issued for different purposes, so you’ll want to ensure that the loan you get does not have any restrictions.
These loans are issued by many different banks, credit unions, online lenders, and loan brokers. If you don’t know where to start, you can see our recommendations for the best personal loans for business funding. Upstart, for instance, is an excellent provider as it has no minimum credit score requirement but can offer competitive rates and terms.
7. Funds from Friends and Family
Who It’s For & How to Apply
This is an option if you have a network of personal or professional connections willing to finance your startup. Funding can come in several forms, including a loan, a gift, or equity in the company.
Considerations for this type of funding include the potential impact on the relationship if the business does not perform well. Additionally, if you decide not to use a loan, the scenarios below could complicate the day-to-day business operations:
- Unwanted business advice: If a family member or friend has shares in the business, they’ll also want input on the long-term business strategy. This may be less than ideal.
- Potentially unrealistic business valuations: Business owners often overvalue the new startup, which gives family and friends an unrealistic expectation of a return on their investment.
- Loan obligations for owners: Selling business shares to family or friends may require them to be liable personally for future financing applications.
What to Consider Before Getting Franchise Financing
Getting franchise financing is a lengthy and complex process that can end up being very costly if you make the wrong choices. To maximize your chances of success, we recommend taking note of the following suggestions:
- Choose a good franchise: You should have a specific franchise in mind before approaching a lender. Consider location, historical performance, startup, and operating costs, and brand value when choosing a franchise.
- Check out the FDD: This is the most reliable way to figure out the estimated startup and operating costs for your franchise. Have a lawyer and accountant review the document before you agree to purchase a franchise.
- Request a regional FDD: This can help you understand how the franchise performs in your geographic location.
- Create a solid business plan: Many people assume that just because they’re starting a franchise, they don’t need a business plan. Even if a franchise has numerous locations throughout the country, each unit is an independent business with unique strengths and weaknesses. For guidance, see our article on how to write a business plan.
- Improve your personal credit score: Your personal financial history and credit score will be critical when applying for financing, especially early in the history of your franchise. Pay bills on time, reduce the amount of credit you use, and be selective about how many loans you apply for. One of our articles has more tips on improving your credit score.
- Maximize your personal investment: Bring as many personal resources as possible to the table. This decreases your reliance on external financing and shows a personal stake in the franchise.
- Gather collateral: Having collateral will go a long way toward getting approved for a franchise loan, particularly an SBA or bank loan. If you’re buying real estate, then it can serve as collateral. If not, then personal real estate, business equipment, or other assets will often work to secure your loan.
- Don’t do it alone: It’s important to find help in your financing process. The more people involved in your effort, the more resources you’ll be able to draw from during the process.
Franchise Financing Costs to Consider
It’s important to consider all of the costs associated with opening and running a franchise. Failing to do so could result in running out of funds or experiencing cash flow shortages.
The FDD should outline most of these fees. Since federal regulations require you to be provided with this document at least 14 days before being asked to sign paperwork or provide any type of money, we recommend first reviewing it with a lawyer and accountant.
Here are some of the costs that should show up in the FDD:
- Initial franchise fee: One-time fee that often ranges from $20,000 to $30,000 but can be higher for well-known national brands.
- Ongoing royalties: These generally range from 4 to 8% of gross revenues and may be paid weekly or monthly.
- Net worth/liquidity: Large franchisors won’t even consider you if you don’t bring a certain amount of net worth and liquid assets to the table.
- Hiring costs: In addition to the cost of hourly wages for employees, there’s a cost to the time it takes to hire and train employees and the costs of employee benefits, health insurance, and business insurance.
- Equipment, marketing, and other miscellaneous costs: You may be assessed a weekly or monthly marketing fee apart from royalties to pay the franchisor for marketing material. Equipment purchase is generally a high startup cost for a franchise.
Pros & Cons of Franchise Financing
Frequently Asked Questions (FAQs)
Lenders typically view it as less risky, so it can be easier to get. This is because the franchise will already have an established brand name recognition, customer following, and a business plan that has been shown to be successful. This is supported by data we gathered on the top SBA funded franchises, showing default rates as low as 0%.
Almost any type of loan can be used to finance a franchise—unless specifically prohibited by the lender or franchisor. Examples include term loans, business credit lines, personal loans, and mortgage loans.
Funds you receive can be used for any business-related purpose—unless specifically prohibited by the lender. Examples include franchise fees, equipment, payroll, inventory, furniture, fixtures, and building renovations.
Bottom Line
Purchasing a franchise can be easier than starting your own business from scratch due to the brand name recognition. You’ll be able to get advice from other franchise owners and get a head start with a business plan that has already proven to be successful. However, initial and ongoing franchise costs can be substantial, and it’s important to consider multiple funding sources to ensure you make the most of your money.
