Financing Guide for the First-Time Franchisee

franchise financing

The Problem with Franchise Financing

In my experience, it is extremely discouraging for first-time franchisees to learn the hard way that the lending sources who helped them buy their house or car may not be able to help them finance their franchise opportunity. The long and difficult financing process (made more complex after the recent US economic recession) can take the wind out of the candidate’s sails, and many unprepared individuals give up at the first or second financing setback. No one can help an entrepreneur who has already given up!

On the other hand, the difficulty in new franchise financing has created a huge drag on most franchisor’s growth, and many companies have responded by focusing on attracting more candidates to make up for the elevated attrition rates in first-time franchisees. My job is includes helping create a successful outcome for candidates already in the process.)

Hope exists for those who do their due diligence, seek appropriate counsel, and persevere. Many franchises have proven business models, plenty of brand awareness and standardized systems and processes. In fact, the first-time franchisee has a huge advantage over other entrepreneurs who are generally considered to carry much greater financial risk.

This is a quick financing reference for the new franchisee.

Conventional Methods of Financing

  • Rollover for Business Startups (ROBS): A ROBS provider (such as Guidant, FranFund or Benetrends) helps you take money from a retirement account, a 401(k) or traditional IRA, and invest it in your franchise without paying income taxes or early withdrawal penalties. A ROBS is not a loan, so there is no principal or interest to pay off, and you can use your income to grow your franchise.

  • Banks and Credit Unions: Believe it or not, franchisees have a statistically much easier time getting loans from banks or credit unions than other startup entrepreneurs. This is because most franchisees are associated with proven business models and well-recognized brands. The application process is slow and very detailed, and the lending institution might ask for personal collateral. However, you will be able to get lower interest rates. Bigger the brand, usually more favorable the terms!
  • Franchise Financing Company: These third-party lenders have an existing relationship with the franchiser or franchise advisor. Due to process standardization, the application process and the funding will be faster than the other sources. Franchise-Specific Lenders help franchisees avoid a slow, long, tedious process, although these options carry higher interest rates than banks, they offer speed, convenience, and usually require no collateral. Their specialization in financing franchises is invaluable to first-time franchisees.
  • SBA Loan: Don’t forget to look into the Small Business Administration’s 7(a) Loan Program. The Small Business Administration (SBA) doesn’t make loans— however, it guarantees loans made by banks and credit unions. These loans become more secured from the lender’s perspective because the SBA promises to pick up some of the cost in the event that you cannot repay the loan. Franchisees have a higher chance of being approved for SBA loans than other entrepreneurs. The SBA has a registry of pre-qualified franchises they’ve vetted in the past. If your brand isn’t on the list, you can still apply, but the process will take longer.
  • Online Lender: These lenders are much faster and easier to qualify for than a bank or SBA loan, which means they are ideal for businesses that need financing in a hurry. However, online lenders normally require at least a few months in business before they trust you enough to grant you capital. The longer you’ve been in business, the better your interest rates and fees will be. Here are some examples: https://www.ondeck.com, https://streetshares.comhttp://www.fundingcircle.com.
  • Line of Credit (LoC): For temporary cash flow issues or equipment repairs, you may want to get a line of credit. Much like a credit card, you can draw from your credit line at any time, and you’re only charged interest on the capital you’ve drawn. Lines of credit are available from a variety of sources including banks, credit unions, and online lenders.
  • Equipment Financing Companies: If your franchise requires expensive equipment, consider getting an equipment loan or lease. Loans are best for equipment that will be useful for a long time; leases are best for equipment that wears out quickly or becomes obsolete. Whichever you choose, you’ll be able to pay in regular installments instead of paying the full cost up-front.
  • Grants and Incentives: Start by checking your state and local job-creation programs. Some offer tax credits, loans, or other incentives to start new businesses. Also, see if you qualify for additional financial assistance through governmental programs for veterans, minorities, and women.
  • Franchisor Financing: Parent corporations can help with financing, too. Many have in-house financing programs, are partnered with low-interest lending institutions, offer equipment buy-backs and discounted franchising fees, or sometimes even just provide useful recommendations.

How Does a Franchisor Help

  • Participate in the SBA Registry: When a franchise joins the SBA registry, their franchise agreement is reviewed by the SBA and approved for use with all franchisees. This means loan applications for franchises on the Franchise Registry are processed faster by the SBA and its lenders, because the respective franchise agreements do not need to be reviewed for each individual franchisee situation.
  • Provide a Bank Credit Report: This document gives your lender basic information about the franchise in terms that banks easily understand, which can speed up the approval process. Legally, the franchise agreement is the only document the franchise can use with you personally as the franchisee, so they can only provide a bank credit report directly to the lender. But if you’re working with a lender, let your franchise know and ask them to send over a credit report.
  • Offer a List of Lenders: In my experience, most brands have a shortlist of lenders with whom they know their franchisees have been successful. If you talk to your franchise or your advisor, you may be able to get a list of recommended lenders who may be more amenable to approving your application. This will help you avoid wasting precious time completing applications with lenders who have a low rate of approval for franchise loans.
  • Match You with a Lender: Either the franchisor has an in-house financing specialist who helps guide franchisees through the lending process, or they partner with a third-party advisors, such as myself, to help facilitate financing. Franchisees of big brands are able to quickly and easily navigate through the lending process, and work with lenders who are known entities to the brands.
  • Build Strategic Relationships with Lenders: Some brands or advisors build relationships with particular lenders over time, to the point that those lenders effectively allocate funds for a certain number of qualifying franchisees of that brand. Since the lender already trusts the brand or franchise advisor, the qualification standards may be more forgiving than they would be through an independent lender.
  • Guarantee Your Loan: Occasionally, certain franchises are willing to help their franchisees qualify for loans by offering a guarantee program. These programs work similar to the SBA’s loan guarantee program, meaning that the franchise takes responsibility for paying back a certain percentage of the loan in the event that you as the franchisee may default on your loan payments. Guarantee programs can make a huge difference in a franchisee’s ability to qualify for a loan. However, they are rare, and typically offered on a case by case basis. If you’re already working with a franchise but struggling to obtain financing, ask if a guarantee program is something they’d be willing to consider.
  • Provide Internal Financing: Knowing that financing is typically the primary barrier to opening a franchise or adding additional units to an existing franchise network, a few franchisors have gone so far as to take the lending process in house. This is a trend that experts agree will continue into the future to reduce dependence on outside funding sources to grow the franchise company.
  • Waive Startup Fees: The specifics of franchisor fee (startup charges, royalties, marketing, etc) are included in the Franchisor Disclosure Document (FDD). Some franchisors do end up waiving a portion of their fees to lower the financial burden on the new franchisees.

Most first-time franchisees consider financing as one of their biggest hurdles in their entrepreneurial journey. Sadly, what works for one candidate may not work for another, and sometimes raising money at unfavorable terms is worse than not getting financing at all. I am happy to offer a free consultation to those who are considering franchise ownership, but are not sure they understand all the options when it comes to funding.