Beginner’s Guide to Franchise Financing

You want to open a cleaning franchise business. You have a business plan in place. You know all the necessary expenses. You look to commercial banks for financing.  But your credit score isn’t strong enough.

Then, you look to alternative loan companies and investors. They’re not interested in your business plan.

Finally, you turn to family and friends for money. But they don’t have money to lend you.

Where do you turn?

In this case, the franchisee could have turned to the parent company for financing options. Many franchises offer direct financing. Or, the parent company is in direct contact with lenders who cater to franchise owners.

But what do you do if the company doesn’t offer franchise financing? This article will show you some options for financing a franchise. Read on if you want to know more.

Company Lending

The easiest way to get financing is through the company itself. Companies know the risks and burdens of being a franchise owner.

Therefore, they’re typically willing to lend money at lucrative rates and terms. The loans are also tailored to the needs of the franchisees. And, franchisor financing may also offer financing for setup costs and other expenses.

Company financing is a growing trend. Further, you can find loan companies that offer loan packages to franchisees alone. With that, the terms and conditions vary based on the company.

Also, creditworthiness will factor into your eligibility. The interest rates vary as well. You could end up paying a higher interest rate under a company financing program. You may also need to contribute collateral.

Regardless, read the terms and conditions before signing. Moreover, have an attorney read over the terms before you sign any papers.

Traditional Lending

You can get financing through banks or loan companies. However, the standards are usually more stringent than other lending options.

Before applying for a loan, ensure that you have the following:

  • Good credit
  • Business plan
  • Strong financial history

A business plan is important. Lenders need to know about your business goals. The good news is that traditional institutions are more likely to lend to franchises. Lenders favor an established brand that has a proven record of generating revenue.

Standard lending usually requires collateral as well. Those with good credit scores will also have to put down collateral. The amount that borrower needs to contribute is usually around 20 percent.

If you’re trying to get franchise financing with bad credit, you may have to contribute more collateral. Or, you may have to pay a higher interest rate.

You stand a better chance of getting financing if you have an existing relationship with the lending institution. Your experience in a particular industry may increase your chances as well.

Government-Backed Lending

If you don’t have the experience and connections, a loan from the Small Business Administration (SBA) is another option. An SBA loan is a loan where the government guarantees a certain percentage of the loan to the lender.

You can apply for an SBA loan through your chosen lender.

SBA loans have longer terms and lower interest rates. The interest rate could be as low as six percent under an SBA loan. With that, these types of loans are very competitive.

You may have to wait longer before gaining acceptance. Additionally, you must contend with extensive paperwork to apply. Finally, the SBA usually reserves these loans for top-notch borrowers.

This means that new franchises will have a harder time qualifying. Depending on the lender, you may need a credit score of anywhere between 620 and 640 and above.

The SBA also wants to see a lengthy business history.  They also look for an established business record before approving an application.

Alternative Lending

If you an SBA is beyond your reach, you have several alternative lenders at your disposal:

  • Credit unions
  • Community investors
  • Small loan companies

In the case of a credit union, you would need to have a pre-existing relationship with that institution. However, credit union financing usually comes with lower interest rates and better terms than banks. And, you’ll stand a higher chance of getting approved through a credit union.

If a credit union isn’t an option, consider community investors. These are local investors who lend to members of the community. Community investors usually have less stringent requirements.

And, you may get a better interest rate in the process. However, each investor has his or her own terms and conditions.

Many alternative loan companies may have relaxed standards as well. They also tend to market potential borrowers with bad credit or messy financial histories.

With these loan companies, you can get the following loan types:

  • Cash advance
  • Business term loans
  • Equipment financing
  • A business line of credit

With these loans, you may pay a higher interest rate. However, the rate will depend on your credit history. Further, financing from loan companies usually has shorter terms.

Family and Friends

If you don’t want to borrow from any institution, you can make your family and friends investors. You could also turn your business venture into a family business.

You may come across a family member or friend who wants to shift jobs or careers and join your franchise.

With that, you should always put down everything in writing. Draw up a lending agreement in the same manner as any other contract.

Retirement Funds

If your family isn’t an option, consider financing a franchise with your retirement account if you have one. You can borrow funds from your 403 (b) or 401(K) to finance a franchise. You could also withdraw money from a ROTH IRA.

Always consult a tax professional before withdrawing money to finance a business.

Franchise Financing Done the Right Way

When it comes to franchise financing, choosing a franchisor finance program is a sound option. You don’t have to look elsewhere when borrowing through a franchisor lending program.

Consider financing through a bank or standard loan company if you have a solid credit history as well. You can also choose an SBA loan if you have good credit.

If you don’t have a good credit history, consider financing through an alternative loan company or community investor. With that, it takes much more than financing to start a successful franchise. Click here for more information on the ins and outs of franchise ownership.