Finding the Right Financing Option for Your Dream Franchise

Business.com / Franchising / Last Modified: November 15, 2017
Photo credit: Gustavo Frazao/Shutterstock

When it comes to owning a franchise, there are many financing avenues to explore and many factors to evaluate. Here are some of the financing options available to potential franchisees and tips on how to make the right choice.

Franchise ownership is an ideal way to make the leap to being a business owner. The great thing about becoming part of a franchise system is that your leap comes with the support and guidance of an established business.

In fact, the International Franchise Association estimated the number of franchise businesses in the U.S. to increase by 1.6 percent in 2017 and contribute $426 billion dollars to the GDP across the many franchise categories: quick service restaurants, personal services, business services, commercial and residential services, retail products and services and more. 

If you are considering this route, you have to think about how to finance your dream. There are many financing avenues and many factors to evaluate to fully understand all of your options before you make a decision. One exciting thing about exploring franchise ownership is it's often easier to obtain financing as a franchisee than as a new, independent business owner.

What are some of the financing options available to you as a potential franchisee?

Most bankroll their franchise through some form of self-financing. This can mean a home equity loan, a second mortgage, using money from savings or even withdrawing funds from your retirement account. Here is a quick overview of some of the most popular financing options.

  • Rollover for Business Startups (ROBS). ROBS allows you to use money in your retirement accounts (either a 401(k), traditional IRA or another eligible retirement account) and invest that money in your franchise. The advantage of this option is that you do not have to pay taxes or an early withdrawal penalty for removing these funds. With that said, it is not a process that is simple: You will need the help of an experienced attorney and CPA and will need to work with a company that specializes in ROBS transactions.

  • Small Business Administration Loans (SBA). SBA loans are government-guaranteed loans. They are a great choice for financing your franchise dream because they offer long repayment terms and low interest rates. However, qualifying for one of these loans requires a solid financial history, including a good credit score (something higher than 650) as well as collateral and a down payment of 10 to 20 percent of the loan amount.

  • Financing through the franchisor. One of the best places to seek out funds is via the franchisor itself. First, the franchisor may have relationships with lenders already. Because of these relationships, the preferred lenders may be more likely to offer financing in addition to the fact that they have a better understanding of the franchise's business model. Also, taking this route puts you in a better position to negotiate the start-up and operating costs

  • Home equity loan or line of credit/second mortgage. This is an option for homeowners who have equity in their home. You can borrow against the equity to help finance your franchise. The rates for a home equity loan generally range from 2 to 7 percent, depending on your credit score. The catch is if you have issues repaying the loan, your home is on the line.

  • Family and friends. If you have family members or friends who are willing to invest in your franchise, this could be a fast (and low-interest) way to raise the necessary capital. Of course, the downside is that you are risking a loved one's money, and there are potential pitfalls with this arrangement. Treat this arrangement as seriously as you would a loan from a bank by drawing up some sort of documentation so it is clear for all parties what the terms of repayment will be.

Now that you have an idea of what options are available to finance your dream of owning your own business, how do you decide which choice is best for you and your situation? Consider these five questions:

  1. What is the total cost of financing (including interest rates, fees to secure financing, etc.)?

  2. What, if any, of my assets are at risk as collateral?

  3. What are the terms and conditions if I default?

  4. How will the total and monthly repayment cost work into my current and expected cash flow?

  5. What is the amortization schedule of the debt? How long do I have to repay the loan? Will my monthly payments or interest rates change over time?

In addition, consider the start-up costs and ongoing fees. These can vary greatly from one franchise opportunity to the next. Make sure you have a clear picture of your total financial exposure, not just initial costs but what your responsibility will be month to month.

For the purposes of comparing one opportunity to another, it's important to focus on two numbers:

  • Initial fees. The franchise fee is what you pay when you buy a franchise. You write this check to the franchisor when you sign a franchise agreement. It's the cost of entering the franchise system and is typically a flat rate. The franchise fee is just a portion of what you will need to open your doors. Store build-out, computer equipment, office supplies and a vehicle are just some of the other items that may be a part of the initial fees.

  • Ongoing fees. Recurring and occasional fees, including royalties, are required by nearly all franchisors in return for their ongoing support. Typically, royalty fees are a percentage of sales. Some companies, though, charge a flat fee on a weekly, monthly or yearly basis.

Also, pay close attention to the information contained in the Franchise Disclosure Document. Don't hesitate to have the franchisor clear up any figures that you don't understand and, as always, talk to other franchisees to get firsthand accounts.      

For those with an entrepreneurial drive, owning your own business represents the opportunity to control your own destiny and financial future. Those dreams don't have to be exclusive to the well-heeled and experienced business people. Franchising opens a world of possibilities for all manner of people to pursue their dreams. It's just a matter of finding the right opportunity for you.

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