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Buying a franchise can help entrepreneurs start a business and increase their income, but many require an initial investment of over $250,000. For this reason, franchise financing is often necessary to start a new business or to expand existing locations. There are several types of franchise financing, but the best franchise loans come with accessible eligibility requirements, a streamlined application process, and a low cost of borrowing.
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Best Franchise Financing Options
Just as there are several types of business loans, business owners have several options when choosing franchise financing. That said, some types of financing are more appropriate for new franchisees, while others are better suited to those trying to grow their existing franchise business or need help with operating costs.
Here are some of the most popular ways to finance a franchise:
1. Online business loans
Online business loans are term loans that potential borrowers can apply for online without having to visit a physical bank. Alternative lenders offer a simpler application process that can be completed online. Loans are generally available for up to $500,000 or more and, as with traditional business loans, borrowers receive a lump sum disbursement.
While online business loans can be a great way to fund franchise growth, they may be less accessible to startups and new business owners. Prospective borrowers trying to purchase their first franchise may struggle to meet the minimum business time and annual revenue requirements of some lenders.
2. Commercial lines of credit
Lines of credit allow borrowers to have access to cash up to a borrowing limit established according to their needs. Business lines of credit range from $2,000 to $250,000, with interest rates between 10% and 99%. Interest accrues only on the outstanding credit balance, and borrowers can pay off their balance and reuse their line of credit until the end of the drawdown period, usually between 12 and 24 months.
Business owners can use their entire line of credit to finance a franchise, but this form of financing is best used for ongoing operating costs. Lines of credit are also suitable for experienced franchisors who want to expand their current business, rather than new franchisees who may not qualify.
3. SBA Loans
The SBA offers small business owners a wide selection of loans, including its popular 7(a) loan program. Loan amounts range up to $5 million and the funds can be used for most business purposes, including buying a franchise. That said, SBA loans involve a lengthy application and approval process and may not be suitable for borrowers who need quick access to cash.
4. Of the franchisor
Some franchisors streamline the financing process by helping new franchisees get loans and offering a discount on fees. However, this offer is franchise specific and not all prospective business owners are eligible for support. Visit the company’s franchise website to see if it offers financing, and consult the franchise disclosure document for any relevant financing information.
Tips for comparing franchise financing options
The best franchise financing option depends on the unique needs of business owners. For this reason, it is important to evaluate financing types and lenders to determine the best solution. Consider these factors when comparing franchise financing options:
- Compare each lender’s credit, time in business and annual revenue requirement
- Make sure the lender offers loans large enough to finance your purchase
- Calculate the installments required by each lender, as well as the estimated monthly payments
- Review interest rates and other fees
- Determine if the lender has experience financing franchises
- Assess whether the franchisor offers any incentives, such as reduced fees
What is franchise financing?
Franchise financing is a type of loan that helps future business owners finance the purchase of a new franchise. Traditional business loans can be used to purchase a franchise, but some loans and lenders are better suited for this type of business. Many franchisors also offer financing specifically tailored to the business and therefore better suited to the nuances of starting a new franchise than standard commercial loans.
How Franchise Financing Works
Franchise financing allows business owners to finance the initial start-up of a new franchise or to expand an existing business. To finance a franchise, business owners can access funds directly from the franchisor or work with an online lender or other financial institution. Qualification requirements vary by lender and type of financing, and the approval process can take anywhere from a few minutes to at least 10 days.
In the case of an online business loan or a loan from the United States Small Business Administration (SBA), approved borrowers receive funds in a lump sum and make monthly payments over a specified period. Alternatively, commercial lines of credit can be used to cover franchise costs as needed for the duration of the drawdown period.
How to Apply for Franchise Financing
The process for obtaining a business loan varies by franchise, type of financing and lender. However, there are a few general steps you need to take to get the money to buy a franchise. Follow these steps to apply for franchise financing:
- Check your personal credit score. Begin the financing process by familiarizing yourself with your personal credit score and your credit report. In general, lenders look for a FICO score of at least 600, but higher scores allow borrowers to qualify for more competitive rates. Also check your credit report for any errors and, if any, dispute them before applying for a loan.
- Organize financial documents. Application requirements vary by lender, but most financial institutions review certain financial documents to assess the risk a borrower poses. For example, most lenders need to see a copy of the signed franchise agreement, personal and business financial statements and tax returns, and information about current and previous loans. To prepare and simplify the application process, compile these documents in advance.
- Create a business plan. In addition to preparing financial documents, write a business plan that outlines a roadmap for your franchise. This document should detail the franchisor-franchisee relationship and how the funding will be used to help the business succeed.
- Submit an application. Once you compile the necessary documentation, submit a loan application through the lender of your choice. Depending on the lender, it can be as simple as navigating to a website and following an online application tool. More traditional lenders may require you to visit a branch or complete a paper application. In any case, the bank may contact you to request additional information or documents to facilitate its examination.
- Wait for approval. Typically, lenders take between one and 10 business days to make a loan decision. However, some online lenders may offer immediate or same-day approval. Monitor your email while you wait for a response so that you can respond to any outstanding questions from the lender as quickly as possible.
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Frequently Asked Questions (FAQ)
What are the costs of opening a franchise?
The costs of opening a franchise vary depending on the franchise and the requirements stated in the franchise agreement, but can range from $75,000 to $500,000. These costs typically include franchise fees between $20,000 and $50,000, as well as legal and accounting fees and money to build a new location.
New franchisees should also provide working capital, funds to purchase supplies and inventory, and money to cover living expenses and travel expenses while training under the direction of the franchisor.
Do franchises offer financing?
Franchises can offer several tools to help franchisees finance their new businesses. Internal financing is offered by some companies, but it’s not incredibly common.
However, many franchises help new business owners by offering incentives and building relationships with preferred lenders. This can make it easier for a potential franchisee to find a lender who knows the specific franchise requirements. Finally, some franchises provide access to financing consultants to streamline the financing process.
Is it difficult to buy a franchise?
Buying a franchise can be difficult without access to the money to do so. High start-up costs can be difficult to finance without strong personal credit, and ongoing royalty payments reduce income once the business is up and running. Beyond the expense, buying a franchise also involves signing a contract and meeting the operational requirements set forth by the franchisor.