Opening a new franchise has many benefits and doesn’t come with as much risk as starting a company from scratch. That said, franchising does require a significant investment due to the high initial fees and startup costs.
Planning to purchase a new franchise but aren’t sure where to start when it comes to securing funding? You have come to the right place! I know from experience how much of a struggle it can be to finance a franchise. In this post, I will break down everything you need to know about franchise financing and share some of my top tips for securing funding.
Key Takeaways
- Traditional bank loans are a common financing option for franchisees, often requiring a strong credit history and collateral.
- The Small Business Administration (SBA) offers loan programs designed for franchisees, typically featuring favorable terms and interest rates.
- Some franchisors provide in-house financing options to help franchisees cover startup costs.
- Alternative funding methods include home equity lines of credit (HELOC), Rollovers as Business Startups (ROBS), and crowdfunding.
- Various online funding tools can connect aspiring franchisees with lenders to facilitate the financing process.
9 Best Options for Financing Your Franchise
Depending on the type of franchise you plan to purchase and the industry, you’ll likely need between $100,000 and $300,000 to get started. The reality is that most people don’t have this kind of cash lying around. On the bright side, there are quite a few different choices for financing a franchise, so you won’t have to rely solely on your own funds. Franchisees often combine a few of these different funding options.
1. In-House Franchisor Funding
One of the most convenient ways to receive financing is directly through the franchisor. Many franchisors offer in-house funding programs, which make the process of financing a new franchise much easier. These programs can vary significantly. For example, some parent companies cooperate with lenders who provide lower interest rates to new franchisees, while other franchisors will offer funding directly from their own pockets. Some corporations even offer flexible repayment terms, which allow you to pay back your debts based on the profit you make, putting less strain on your cash flow.
Your franchisor knows how much start-up capital you need better than any other lender, making this the easiest and often the cheapest way to borrow money for a franchise.
When available, in-house franchisor funding is likely your best bet for financing, but it is not an option that all parent companies offer.
Popular Franchises with In-House Financing Options
2. Standard Bank Loans
If your franchise does not offer in-house funding, the next best place to look for financing is with a standard bank. If you have a good credit score and have crafted a strong business plan, you shouldn’t have much of a problem securing a commercial loan to fund your franchise. That said, your interest rate and approval amount will vary depending on factors such as the franchisor’s reputation, the current economic climate, and your credit score.
It’s also worth mentioning that banks often ask for collateral such as properties, savings accounts, or other assets in order to secure the loan. If you default on the loan, the bank may have the right to seize the assets.
Bank Loan Options for Franchisees
Almost every major bank in the USA will offer some sort of small business loan catered toward franchisees, but here are a few of my top picks.
3. SBA Loans
SBA loans are a specific type of bank loan offered by most major lenders that are backed by the U.S. Small Business Administration. The SBA essentially guarantees a portion of these loans (up to 85%), which are offered by banks. This reduces the risk for lenders and makes it easier for small business owners to access funding. These federal-backed loans generally come with lower interest rates and longer loan terms. SBA loans also tend to require smaller down payments, making them a great option for franchise owners without large amounts of capital.
You may ask, “If SBA loans are so great, then why doesn’t everyone get one?”
The reason is that SBA loans come with strict criteria and a lengthy application process, which can be a major hurdle for some franchisees. For example, for SBA 7(a) loans, applicants need a strong credit rating of at least 670 and a solid business plan to qualify.
4. Personal Financing
While not everyone has the funds to personally finance their own franchise, if you have the means to do it, you could skip over all of the bureaucracy and start your franchise almost immediately by personally financing it. With that said, you’ll need to weigh the pros and cons of using your life savings for this venture. If you empty your savings account for this franchise, it could be a pretty big gamble. While franchising is definitely one of the lower-risk investment options, there is always a risk, so don’t put all your eggs in one basket.
Beyond simply taking money out of your savings, you could personally finance your franchise by using a business credit card to supplement whatever funds you do not have. However, this is not always a feasible option, as your credit limit may not be high enough to finance the franchise. Furthermore, if you are unable to make the minimum monthly payments to pay the credit card company back, you may end up with crippling debt. And isn’t the whole point of franchising to reach a level of financial stability?
5. Crowdfunding
One of the most innovative ways to fund your franchise is through crowdfunding. There are a few different types of crowdfunding, so you can pick the option that best aligns with your goals:
- Debt crowdfunding: Also called “peer-to-peer lending” or “P2P lending,” debt crowdfunding means you get a loan that you pay back to the investors.
- Equity crowdfunding: You seek investors who take a cut of your future profits.
- Reward crowdfunding: Investors contribute funds to your franchise for a reward, such as a product or service.
- Donation crowdfunding: A donation-based funding where backers donate to your project because they believe in it.
There are pros and cons to each type of crowdfunding. However, as a whole, crowdfunding involves low financial risk (unless you choose debt or equity crowdfunding) and is a very attractive franchise financing at first glance. The challenge lies in the fact that it can be difficult to find investors who are passionate enough about your franchise to invest in it or donate their hard-earned money.
6. Friends and Family
Borrowing money from friends and family can be tricky business, but it can be a great way to find the funds you need to open your franchise. If you decide to go this route, make sure you treat it as a true business deal in order to avoid any fights or misunderstandings in the future.
Franchises aren’t cheap, so if your friends and family are helping to finance your business venture, they’ll be putting a lot of money on the line as well. So, protect them and yourself by writing a contract with information regarding the repayment terms and other expectations. Make sure everyone understands the agreement before signing. The last thing you need is to strain a relationship due to business.
7. Home Equity Line of Credit (HELOC)
Also called a “second mortgage,” a home equity line of credit (HELOC) is a type of loan that uses the equity in your home as collateral. In order to get this type of loan, you’ll need to own a home and have equity in it. In other words, how much you owe on your home must be less than the value of the home. How much money you can actually borrow depends on a number of factors. But as a general rule, you can expect to borrow up to 85% of the value of your home minus however much you owe.
So, if your home is worth $500,000, and you owe $400,000, you may be able to borrow up to $85,000.
In order to get a HELOC, you’ll also need:
- A steady income
- A good credit score
- Credit history
- Employment history
A HELOC tends to have a lower interest rate, plus the interest might be tax deductible, which makes it a very attractive type of loan. On the flip side, consider that you are using your own home as collateral, and the HELOC interest rate is generally variable.
8. Rollovers as Business Startups (ROBS)
Rollovers as business start-ups (ROBS) allow you to use your retirement savings, such as those in your 401(k) or IRA, to fund your franchise. If you have a significant amount of money saved for retirement, this may be a great option to consider to invest in your franchise, as this is not a loan, meaning there are no payments or interest to consider.
ROBS sounds like an ideal means of financing your franchise, but consider that you’ll risk losing your retirement savings if the franchise fails. If that happens, you’ll want to have some kind of fallback or some kind of cushion on your retirement savings so that you’re not losing more than you can afford.
9. Other Lenders
Beyond the above more traditional methods of finding funds to finance your franchise, there are other lenders to consider, namely online lenders and so-called “loan sharks.”
- Online Lenders: Online non-bank lenders tend to have more lenient approval criteria compared to traditional bank loans and have a huge range of loan limits, repayment terms, and interest rates.
- Loan Sharks: Loan sharks are a potential source of funding that should only be used as a last resort. These lenders are known for their crazy high interest rates, which can cause problems for you down the line.
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How to Get Approved for Franchise Funding
Securing financing for your new franchise is, unfortunately, not automatic. First, you’ll need to be approved for a loan. Here are some of my top tips for getting a franchise loan approved.
- Check your credit history: The first thing any lender is going to do is check your credit score and credit history. If you have good credit (650+), you won’t really have anything to worry about in this regard. That said, in general, the higher the credit score, the more likely you are to be approved.
- Craft a strong business plan: Lenders are also going to want to look over your business plan before handing over your franchise loan. Make sure to create a thorough business plan that includes everything about how you plan to run the franchise, including your financial projects, marketing strategy, and operations plan.
- Collateral is key: Most lenders won’t approve a franchise business loan without some sort of collateral. You’ll need to provide physical assets in the event that you default on the loan. Some common examples of collateral are cash, vehicles, real estate, and investments.
- Have a down payment: You’ll typically need to make a down payment on the loan to lessen the risk to the lender. The down payment amount ranges from around 10% to 20%. Lenders tend to require higher down payments from franchisees with lower credit scores or fewer assets to offer as collateral.
- Get quotes from multiple lenders: It is always a good idea to get a few options when looking for a loan. This allows you to compare interest rates, down payment requirements, and collateral before choosing the option that best suits your interests.
How Much Funding Do You Need to Buy a Franchise?
It’s no secret that franchises are not a cheap business endeavor. While buying a franchise is a great way to dip your toes into entrepreneurship without taking major risks, you’ll need some serious capital to get started. As mentioned earlier, most franchisees need around $100,000 to $300,000 in startup money. Here is a breakdown of the different expenses needed for opening a new franchise:
- Franchise Fee: Depending on the industry and the size (and reputation) of the parent company, you’ll generally pay $25,000 to $50,000 for the franchise fee.
- Real Estate and Location Costs: After buying a new franchise, you’ll have to find a location to run it. Location costs for franchises have a wide cost range. You’ll typically need to pay a 3-6 month deposit on the lease when renting a space, which costs between $10,000 and $40,000 depending on the location.
- Inventory: As you might expect, inventory costs can also differ depending on the franchise industry. For example, a retail franchise might require $20,000 to $100,000 or more in initial stock, while service-based franchises will need much less.
- Insurance: Insuring your newly minted franchise is a must in order to protect yourself from legal and financial liability. Depending on the type of coverage your franchise needs, your business insurance policies will cost you around $500 per policy per year or around $700 for a business owner’s policy.
- Built-Out Costs: After purchasing or leasing a space for your franchise, you’ll then need some extra funds to cover the expenses of customizing your location to meet franchise standards, including interior design, signage, equipment installation, and more.
Start Your Franchise Dreams With Franzy
Starting your franchise journey requires careful planning and a clear understanding of your financing options. By exploring the right funding solutions, you’ll be well-equipped to bring your entrepreneurial dreams to life.
Researching franchises is no easy task, and historically, there have not been many good resources to help you make solid, data-driven decisions. Franzy is your trusted partner for connecting with top franchisors, exploring funding opportunities, and making decisions that set you on the path to success.
