When would an owner need franchise funding? There are times when attractive opportunities present themselves to business owners. Perhaps it’s the chance to upgrade to a new POS and order flow system so you can handle more customers. Maybe the franchisor has unveiled a new interior design, and you want to be among the first to move to it. It could even be the chance to buy an existing location in a nearby community. They’re all potentially great ideas … and all demand some level of franchise funding. So where should you turn for the capital you need?
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1. Traditional loan options for franchise funding
The first source many owners think about when it comes to franchise funding is their local bank. While it’s true commercial lenders appear to be eager to make loans, it’s often difficult for franchisees to qualify for affordable financing. For franchisees who do business through multiple locations in a large geographic area, the local bank may not have a large enough coverage area to meet all the needs. That may point the franchisee to large regional or national banks, but those rarely offer the highly personal service business owners prefer.
Because many franchise operations are considered to be small businesses, franchisees might consider Small Business Administration (SBA) loans. SBA loans are actually provided by banks, credit unions, and other financial institutions with federal backing. The SBA determines the interest rates, lending limits, and other key terms … and won’t approve loans for all of today’s franchise concepts, so make sure yours is eligible before you begin all the work associated with applying.
The SBA offers several different loan programs designed to provide working capital or finance the purchase of inventory and commercial equipment. The three most common types of SBA loans, each of which has different lending limits and standards, include:
Those loan limits may not be high enough for your franchise funding needs.
The SBA program helps franchisees and other business owners who might have difficulty qualifying for loans on their own get access to the capital they need. The SBA's guarantee gives lenders an incentive to make loans they might otherwise reject. In addition, interest rates on these loans tend to be lower than comparable bank loans because of limits set by the SBA, and the repayment terms allow borrowers to get longer terms with lower monthly payments.
However, the disadvantages of borrowing through SBA loans may outweigh the benefits. Some of the obstacles franchise owners may face include:
You might be surprised to learn that bank loans are just one of many ways to get the money your franchise business needs so you can grow. What are those options?
You may have noticed we didn’t include franchisors in that list. Many do offer financing, but that doesn’t guarantee you’ll receive the best rates or terms, and their franchise funding may come with painful restrictions. Before you sign any franchise financing agreement, be sure you’ve done your homework, considered all the options, and taken a long look at the best ones. If you’re getting ready to find the money you need to make your franchise funding plans a reality, be careful not to make these rookie mistakes:
This isn’t like signing up for a credit card at a store. All business credit is complex in some ways, and before you begin the process, you need to make sure you understand how that process works. The better you understand it, the better you’ll be able to make the best choice. Specialty lenders like our team don’t drag their feet when making decisions about franchise loans, but there are regulatory processes that just can’t happen any faster. In other words, the process is probably going to take longer than you think, so you shouldn’t wait until the last minute.
Capital isn’t free. Lenders and investors share a common goal: to make money. That’s how the system works. But capital can get confusing, and some less-scrupulous sources of money might neglect to mention extra fees and costs buried in the paperwork. Be sure you understand every detail about rates, fees, and terms before you sign anything.
Lenders conduct what’s known as due diligence to verify that everything you’ve stated is true and that you’ll be likely to repay whatever amount they approve. It’s also important for you to conduct your own due diligence about the lender, especially if you’ve never done business with them. You’ll want to make sure they’re legitimate, meet any compliance requirements, and have a reputation for treating borrowers well.
Wishful thinking is a bad way to determine how much working capital your franchise plan will require. Don’t make the mistake of lowballing the amount you need because you think it will increase your chances for approval. Suppose you’re planning a major remodel of your location. If you use every penny of your working capital to fund it, you won’t be ready for unexpected emergencies or increases in the costs of materials. Calculate what you need carefully -- or work with experts who understand your plans -- and make sure you have a cushion to cover unexpected contingencies.
As we noted earlier, you have plenty of options when seeking franchise funding, but that doesn't mean they're all equally appropriate for your business and your plans. That's why it's so important to explore those options carefully and ask questions to verify your understanding of what's involved. It's also worthwhile to reach out to trusted advisors like your attorney and CPA, because they may be able to point out issues you may not have considered. Doing that kind of homework may seem frustrating because it can slow down your plans, but it will increase the likelihood your funding choice allows you to achieve your goals with less stress and less negative impact on your franchise business.
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