Except with home-based operations, most franchise businesses are going to require that you get some type of funding. The purpose of this funding is to make up the difference between your cash advancement and the franchise’s expenses until it sees a profit. As a rule of thumb, lenders expect you to have at least enough cash to cover 30 percent of the expenses. At the same time, they don’t like you to use more than 75 percent of your cash reserves.
The best source for information regarding funding options is your prospective franchisor. They should be able to answer your questions about the costs and chances of getting different types of financing. Also, franchisors sometimes offer their own financing or have agreements with lenders to facilitate rapid funding of their franchisees.
Businesses become franchises for two reasons: 1) to expand the business, and 2) to raise capital. Because of this, franchisors want to help you open your franchise. One of the ways they do this is through what they call “debt financing.” This means the franchisor carries part of the expense burden. This information plus any terms for franchisor financing should be contained in the Franchise Disclosure Document (FDD).
A franchisor might also have an arrangement with a company that leases or finances the necessary equipment for the franchise. Equipment can be anywhere from 25 to 75 percent of your expenses. By taking this option, you leave yourself with less to finance elsewhere. If the franchisor doesn’t offer this option, you might consider approaching an equipment leasing and financing company as a way of deferring and lowering expenses.
Even though a franchisor might offer funding, you should still check out your other options. After all, your goal is to secure a loan with the best possible terms. (Basically, the money you need, with the least amount of collateral, at the lowest interest rate, and the best repayment terms.) Those savvy in business financing often first try their friends and relatives before moving on to home mortgages, veterans’ loans, bank loans, SBA loans, and finance companies, in that order.
The problem with getting funding from banks or other financial lenders is that once you mention starting a new business, they start asking for collateral. The best form of collateral is your home, making home equity loans popular among those looking to finance a franchise business. You can also use other things of value you might own, such as stocks, bonds, insurance policies, or even IRAs as collateral for a bank loan. Understand that if you default on the loan, you can lose your house and possibly everything else. Only gamble with what you can afford to lose. Even though franchises are usually a safe investment, sometimes they do fail.
When a bank or other lender gives you a loan, they are investing in your business. With this in mind, your best approach is to present yourself as being knowledgeable about your business and possessing the qualities and resources to be successful. You need to have a complete franchise business plan that includes all of your pertinent financial records.
Another possible option is a bank loan that is secured by the U.S. Government. The Small Business Administration guarantees bank loans to small businesses for up to 90 percent of the loan. Banks like these loans because they limit their liability. As with conventional bank loans, you still need to present your business as a worthwhile investment. They are very discerning because banks and lenders tend to eventually sell their SBA loans to third parties. The lower the bank’s overall default rate on SBA loans, the more they get per loan when they sell.
Choose a lender that specializes in franchise loans because they will be more responsive to your business needs. Beginning a new business is not an easy process. Armed beforehand with the right information and knowledge, however, you can avoid the many pitfalls and go on to become a successful entrepreneur.