How to Get Money to Start a Franchise

Securing capital is a significant hurdle for many aspiring entrepreneurs. Franchising offers a structured path to business ownership, but understanding its financial landscape is crucial. This guide outlines financial considerations and funding avenues for launching a franchise.

Understanding Franchise Funding Needs

Embarking on a franchise journey requires a clear understanding of the costs involved. The initial franchise fee is a one-time payment to the franchisor for brand rights and established systems. This fee typically ranges from $10,000 to $100,000, with many popular franchises falling between $25,000 and $50,000. This initial investment differs from operational setup costs.

Beyond the initial fee, franchisees face significant startup costs. These can include expenses for real estate or leasehold improvements, equipment, initial inventory, signage, and technology infrastructure. The total startup costs can vary widely depending on the franchise type and industry, ranging from less than $10,000 to over $5 million, though they commonly average between $50,000 and $500,000.

Working capital covers initial operating expenses before the business generates sufficient revenue. This includes salaries, utility bills, and marketing during the ramp-up phase. Ongoing financial obligations include royalty fees and marketing fund contributions, typically calculated as a percentage of gross sales. Royalty fees often range from 5% to 9%, while marketing fund contributions are usually between 1% and 4%. The Franchise Disclosure Document (FDD) provides a detailed breakdown of all expected costs and financial commitments.

Exploring Common Financing Options

Several common financing options are available for franchisees. One option is Small Business Administration (SBA) guaranteed loans, which reduce lender risk. The SBA does not directly lend money but guarantees a portion of loans made by approved lenders, such as banks and credit unions. This guarantee can be up to 85% for loans of $150,000 or less, and 75% for loans exceeding $150,000, making lenders more willing to offer favorable terms.

The SBA offers various loan programs, with the 7(a) loan being the most common for franchise purchases. These loans can be used for various purposes, including acquiring real estate, purchasing fixed assets, providing working capital, and even refinancing existing debt, with amounts available up to $5 million. Repayment terms can extend up to 25 years for real estate, 10 years for equipment, and 7 years for working capital, offering flexibility. Interest rates for 7(a) loans are tied to the prime rate, with caps set by the SBA to prevent excessive charges. While the SBA does not set a minimum personal credit score, lenders often require a score of 690 or higher, though some may accept scores in the mid-600s.

Another SBA program, the 504 loan, is specifically designed for financing major fixed assets like real estate and large equipment, with a maximum loan amount of $5.5 million. The structure of a 504 loan involves three parties: 40% of the funding comes from a Certified Development Company (CDC), 50% from a third-party lender, and the remaining 10% from the franchisee’s equity injection. Franchisors may also offer direct financing options or maintain relationships with preferred lenders familiar with their business model, which can streamline the funding process for new franchisees.

Beyond traditional debt, some individuals explore Rollovers for Business Startups (ROBS), which allow the use of retirement funds, such as from a 401(k) or IRA, to fund a business without incurring early withdrawal penalties or immediate taxes. This strategy involves forming a new C corporation, establishing a 401(k) plan, and rolling personal retirement funds into it to purchase company stock to provide capital. While ROBS can be an attractive, debt-free financing option, they are complex and can put retirement savings at risk if the business fails, thus warranting careful consideration and professional guidance.

Using personal funds is another common approach, providing immediate access to capital and allowing the entrepreneur to retain full control over business decisions without external obligations. However, this option carries the significant risk of depleting personal savings if the business does not succeed.

Home equity loans or Home Equity Lines of Credit (HELOCs) can also provide capital by leveraging the equity built up in a personal residence. These options often come with lower interest rates compared to unsecured loans because the home serves as collateral. However, this also means that defaulting on the loan could result in foreclosure, making it a higher-risk strategy. Lenders typically allow borrowing up to 80-85% of the available home equity.

Preparing Your Financial Application

Successful franchise financial applications require thorough preparation and a clear presentation of your financial standing and business strategy. A comprehensive business plan is fundamental, outlining the franchise’s proposed operations, target market, competitive analysis, and management team. This document must include detailed financial projections, such as expected revenues, expenses, and profitability, demonstrating the venture’s viability to lenders. A well-crafted business plan serves as a roadmap and a persuasive tool.

Understanding personal financial requirements is equally important, as lenders assess an applicant’s ability to repay the loan. A strong personal credit score is a significant factor, with most lenders preferring a FICO score of 670 or higher. While some SBA lenders might accept scores in the mid-600s, a score below 650 can make securing an SBA loan particularly challenging. Lenders also evaluate an applicant’s net worth and liquidity, often looking for a minimum net worth and a certain amount of liquid assets, such as $125,000 in liquid assets.

Gathering necessary documentation is important before approaching lenders. This typically includes personal financial statements detailing assets, liabilities, and income, along with personal and business tax returns, often for the past two years. Bank statements, both personal and business, are also required to demonstrate financial health and cash flow. Additionally, applicants will need to provide the Franchise Disclosure Document (FDD), a signed franchise agreement, and resumes or biographies of key personnel involved in the business. If collateral is being offered, documentation proving ownership and value is necessary.

Navigating the Application Process

After preparation, the next phase involves navigating the application process to secure funding. Identifying the right lending partner is a strategic first step; many financial institutions specialize in franchise financing or SBA loans, and the SBA’s Lender Match tool can help connect prospective borrowers with suitable lenders. Engaging with a lender experienced in franchise models can streamline the application and approval stages.

After selecting a lender, the process moves to submitting the complete application package. This submission typically includes all the financial documents, business plans, and personal information gathered during the preparation phase. A thorough and well-organized submission can significantly contribute to a smoother review process.

Following submission, the application enters the underwriting phase, where the lender conducts a comprehensive review of the applicant’s financial health, creditworthiness, and the proposed business venture. This often involves due diligence, which may include requests for additional information, clarifications, or interviews to assess risk and viability. For SBA loans, the Small Business Administration also conducts its own review of the application, adding an additional layer to the process.

Upon successful underwriting, the loan reaches the approval stage, leading to the issuance of a commitment letter outlining the loan’s terms, interest rates, and repayment schedule. The final step is closing, which involves reviewing and signing all necessary legal documents, followed by the disbursement of funds. The entire SBA loan process, from application to funding, typically takes 60 to 90 days, varying based on loan type and applicant responsiveness.