Franchise financing allows you to fund the purchase of a franchise or provide working capital for day-to-day expenses. Rates and terms of different types of financing will vary widely depending on the amount of money borrowed, the length of the financing, and the risk to the lender the financing presents.
There are many different ways to finance a franchise, each specifically geared toward a specific phase of the franchising process. Some loan types are best used to fund the initial franchise purchase while others provide your business with the working capital needed to keep growing.
Here are the seven best types of franchise financing and what each is best used for:
- Franchisor financing: Receiving financing from the franchisor with negotiable terms
- Small Business Administration (SBA) loans: Well-qualified borrowers looking for low rates on government-backed loans
- Rollover for Business Startups (ROBS): Business owners with at least $50,000 in retirement savings to use for funding
- Working capital loan: Business owners looking for a quick source of working capital
- Home equity line of credit (HELOC) or home equity loan (HEL): Business owners with equity in their primary residence to use for funding
- Crowdfunding: Startups looking to raise money to buy into reputable franchises
- Friends and family loan: Business owners with friends or family willing to lend money
Financing a Franchise: Loan Options at a Glance
Provider | Loan Type | Maximum Loan Amount | Estimated Annual Percentage Rate (APR) | Maximum Term | Funding Speed |
---|---|---|---|---|---|
Franchisor | Varies* | Varies* | Varies* | Varies* | |
SBA Loan 7(a) or 504 | $5 million | 6.25% and up | 10 or 25 years, depending on loan type | 30 to 90 days | |
No maximum; minimum of $50,000 | N/A; not a loan | N/A | Two to four weeks | ||
$250,000 | 10% to 70% | Six to 12 months for each draw | As quick as one business day | ||
Available equity in primary residence | Prime rate and up | 10 years; usually renewable | 30 to 45 days | ||
$2 million | 7.75% and up | Five to 10 years | Varies | ||
Friends and Family | 1.68%* and up (as of June 2022) | No maximum | No maximum, but a length should be set | Same business day | |
Franchisor Financing: Best for Receiving Direct Financing
The best way to obtain financing for a franchise is directly through the franchisor, if available. There are two advantages to working directly with the franchisor:
- Negotiate startup and operating costs: When opening a franchise, there are items you’ll need to purchase before launching. The costs involved will be noted in the Franchise Disclosure Document (FDD), and negotiating those amounts upfront may encourage the franchisor to absorb some of them, such as franchise fees, which could get discounted.
- Work with the franchisor’s preferred lenders: Franchisors will partner with lenders and can refer you to them for financing. These lenders will be familiar with the brand and needs of the business you’re buying into, so they should be well-positioned to help you succeed.
Terms and rates for any type of financing will be negotiable. While this often means getting great ones for funding, it might not necessarily be the lowest available rates. Be sure to compare the other loan types on this list to ensure you’re getting the best for your business.
Generally, working with the franchisor for some level of financing will help your franchise get off the ground and assist you in building a good working relationship with them. If they don’t offer direct financing, you can often get invaluable advice from them about obtaining funding. Since they have a vested interest in assisting you, they should be a valuable resource.
SBA Loans: Best for Well-qualified Borrowers Wanting Government-backed Loans With Low-interest Rates
If you’re looking for the lowest possible interest rates on funding for your franchise, SBA loans are your best bet. There are two types most often used in franchise financing:
- SBA 7(a) loans can be used as working capital, for leasehold improvements, to refinance debt, or to buy a business or franchise, equipment, and commercial real estate.
- SBA 504 loans can only be used to buy land, renovate or expand facilities, pay for property improvements, and buy fixed assets. You cannot buy a franchise with an SBA 504 loan, but many of the costs of starting a new business can be funded with one.
SBA Loan Terms, Rates and Qualifications | ||
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SBA 7(a) Loan | SBA 504 Loan | |
Interest Rates | ||
Loan Amounts | Up to $5 million | Up to $5 million |
Repayment Terms |
| 10, 20, or 25 years |
Origination Fee | 0.5% to 3.5% | CDC fees 1.5% to 2% |
Loan Packaging Fee | $2,000 to $4,000 | Varies |
SBA Guarantee Fee | Up to 3.75% | 0.5% |
Minimum Requirements |
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Use of Loan Proceeds |
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While SBA loans offer outstanding rates, the biggest obstacle is funding time, as it can take up to 90 days to close an SBA loan. Also, you can’t use funds from SBA loans to cover startup costs—these will have to be covered out-of-pocket.
You also need to have a strong credit profile as you’ll need a personal credit score of 680 or greater to qualify. For more information on what you’ll need to know to obtain an SBA loan, check out our guide on how to get a small business loan.
SmartBiz can help you with an SBA loan to help finance a franchise. It offers SBA loans between $30,000 and $5 million, with repayment terms of up to 25 years. You can apply in 5 minutes on the company’s website, so check it out for more information.
ROBS: Best for Owners With Retirement Funds to Invest
The most important thing about a ROBS is that it isn’t a loan, so there are no payments to make and no interest to pay back. It’s an investment from a personal retirement account used to fund a business.
To qualify for and use a ROBS, you must
- Contribute $50,000 or more from your retirement savings
- Be an employee of the business
- Structure your business as a C corporation (C-corp)
- Be able to fund the setup costs of $5,000 from outside the deferred retirement account
Setting up a ROBS can be very complicated. Before proceeding, check out our guide on ROBS and our list of the best ROBS providers.
Guidant Financial is an excellent ROBS provider. It can assist you with the proper setup and execution of a ROBS account. Visit its website for more information or to speak with a ROBS specialist.
Working Capital Loan: Best for Owners Looking for Fast Funding for Short-term Needs
Whether you need funds to make payroll, finance an equipment purchase, or use as a line of credit for day-to-day expenses, a working capital loan can help with the recurring costs of your new franchise. The most significant advantage to this option is funding time—you can receive a loan or access to a line of credit often within a matter of hours.
Working Capital Loans Rates, Terms & Qualifications | |
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Interest Rates | As low as 4.8% |
Expected APR | As low as 10% |
Maximum Loan Amount | Up to $5 million |
Repayment Terms | Up to five years |
Minimum Credit Score | 575 |
Funding Speed | As fast as one business day |
Note, however, that terms and rates will vary depending on the type of loan or line of credit obtained. While working capital loan providers will lend to borrowers with credit scores below 600, those often come with very high interest rates and fees. The better your individual credit, the better rates and terms you would get.
While you won’t fund large capital projects with a working capital loan, you can cover the smaller, often recurring expenses your business encounters.
If you’re looking for a business line of credit, Bluevine is an excellent choice. It provides business lines of credit of up to $250,000 at rates starting as low as 6.2%. Visit its website to get a funding decision within 5 minutes, and you can even get access to funding on the same day.
HELOC or HEL: Best for Owners With Available Equity in Their Primary Residence
Another alternative to a business line of credit or term loan is a HELOC or a HEL. The critical difference is that qualification for it’s based on the personal credit and income of the business owner. It also depends on the available equity in the business owner’s personal residence.
Interest Rates | As low as the prime rate |
Expected APR | As low as the prime rate |
Maximum Loan Amount | Dependent on the available equity in the owner’s primary residence |
Repayment Terms | 10 years, HELOCs are usually renewable |
Minimum Credit Score | 620 for HEL, 680 for HELOC |
Funding Speed | 30 to 45 days |
A HELOC provides a revolving line of credit similar to a credit card. You receive a credit line and can take draws against the line during the draw period, usually 10 years. At the end, you can either pay the line of credit off and close it, renew the line of credit, or transfer it to an amortizing mortgage loan and pay it down in monthly installments. This is ideal for recurring small expenses like you would use a working capital loan.
Meanwhile, a HEL is a lump sum loan based on the equity in your home. Rather than taking multiple draws against a line of credit, a HEL gives you the full amount of the loan at closing, with monthly principal and interest payments due until the loan is satisfied. This type is ideal for large expenses that you might incur when getting your franchise started.
Regardless of which you apply for, LendingTree is a great provider. It has an online marketplace to ensure you get the best rates and terms for your business needs, so visit its website to get the process started.
Crowdfunding: Best for Startups Looking to Raise Funds to Buy Into Franchises
Crowdfunding might be a good choice if you’re looking for larger financing than a working capital loan, cannot wait for up to 90 days for an SBA loan, have less than perfect credit, and don’t want to pay the extra fees and higher rates involved with alternative loans. It raises money from institutions and individuals and can often bridge the gap between traditional business loans and high-interest alternative loans.
Interest Rates | 7.75% and up |
Expected APR | 7.75% and up |
Maximum Loan Amount | $2 million |
Repayment Terms | Five to 10 years |
Minimum Credit Score | 660 |
Funding Speed | Varies |
One crowdfunding provider that focuses on franchise financing is ApplePie Capital. In addition to crowdfunding, it provides SBA and conventional loans with both fixed and variable rates. Whether you’re looking to purchase new units, remodel, recapitalize, or finance equipment, it has financing options available. Visit its website to learn more.
Friends & Family Loan: Best for Owners With Friends & Relatives Willing to Lend Them Money
One final option to obtain financing for a franchise is a friends and family loan. This type has very lenient repayment terms and excellent rates. However, it often comes with unwanted involvement in the business by investors, so documentation is critical to safeguarding the business.
The IRS sets the minimum rates expected from these types of loans in the IRS Index of AFRs, which is updated every month. Failure to charge the proper interest can lead to tax problems for your business, and if the family member or friend doesn’t charge interest at all, the IRS will see it as a gift—which can also cause tax issues.
Interest Rates | As of June 2022, 1.66% to 2.34% |
Expected APR | 1.68% to 2.36% |
Maximum Loan Amount | No maximum |
Repayment Terms | No maximum |
Minimum Credit Score | None |
Funding Speed | Same business day |
Unless your friends and family are sophisticated investors, taking money as a loan is generally cleaner than selling them a share of the business for three reasons:
- Unwanted business advice: If a family member or friend has shares in the business, they’ll also want input on the long-term business strategy. This may be less than ideal.
- Potentially unrealistic business valuations: Business owners often overvalue the new startup, which gives family and friends an unrealistic expectation of a return on their investment.
- Loan obligations for owners: Selling business shares to family or friends may require them to be liable personally for future financing applications.
What To Know Before Applying for Franchise Financing
There are several things to consider before applying for franchise financing. This section will break down the tips for applying, the costs of running a franchise, and the pros and cons of franchise financing.
Tips for Applying for Franchise Financing
- Choose a good franchise: You should have a specific franchise in mind before approaching a lender. Consider location, historical performance, startup, and operating costs, and brand value when choosing a franchise.
- Check out the FDD: This is the most reliable way to figure out the estimated startup and operating costs for your franchise. Have a lawyer and accountant review the document before you agree to purchase a franchise.
- Request a regional FDD: This can help you understand how the franchise performs in your geographic location.
- Create a solid business plan: Many people assume that just because they’re starting a franchise, they don’t need a business plan. Even if a franchise has numerous locations throughout the country, each unit is an independent business with unique strengths and weaknesses.
- Improve your personal credit score: Your personal financial history and credit score will be critical when applying for financing, especially early in the history of your franchise. Pay bills on time, reduce the amount of credit you use, and be selective about how many loans you apply for.
- Maximize your personal investment: Bring as many personal resources as possible to the table. This decreases your reliance on external financing and shows a personal stake in the franchise.
- Gather collateral: Having collateral will go a long way towards getting approved for a franchise loan, particularly an SBA or bank loan. If you’re buying real estate, then it can serve as collateral. If not, then personal real estate, business equipment, or other assets will often work to secure your loan.
- Don’t do it alone: It’s important to find help in your financing process. The more people involved in your effort, the more resources you’ll be able to draw from during the process.
Costs of Opening & Running a Franchise
Once you receive an FDD, review it with your lawyer and accountant before you sign any paperwork. The franchisor must provide you legally with the FDD at least 14 days before buying a franchise.
Here are some of the costs that should show up in the FDD:
- Initial franchise fee: One-time fee that often ranges from about $20,000 to $30,000 but can be higher for well-known national brands.
- Ongoing royalties: These generally range from 4 to 8% of gross revenues and may be paid weekly or monthly.
- Net worth/liquidity: Large franchisors won’t even consider you if you don’t bring a certain amount of net worth and liquid assets to the table.
- Hiring costs: In addition to the cost of hourly wages for employees, there’s a cost to the time it takes to hire and train employees and the costs of employee benefits, health insurance, and business insurance.
- Equipment, marketing, and other miscellaneous costs: You may be assessed a weekly or monthly marketing fee apart from royalties to pay the franchisor for marketing material. Equipment purchase is generally a high startup cost for a franchise.
FranchiseGrade.com has a free tool that lets you compare the startup costs of different franchises and has data on more than 2,500 franchises. Visit their website for more information.
Pros & Cons of Franchise Financing
PROS | CONS |
---|---|
Can be easier to finance than a new business: The business comes with an established performance history, so this makes financing a franchise easier than a brand new business. | False expectations of success: Even though a franchise offers you an established market and brand presence, it is still a business that requires skill to operate successfully. |
Often seen as less risky: Lenders can easily evaluate a franchise's success and measure standard default rates. With this information so readily available, they can approve funding with a higher level of confidence, making the process easier for the borrower. | High initial payout and startup costs: Unlike other startups which can slowly scale over time, a franchise needs the business to be completely operational from the onset. This requires full staffing, merchandising, and inventory before you can even open. |
Bottom Line
There are built-in advantages to purchasing an existing franchise rather than starting an entirely new business. However, it’s essential to know what to expect in the franchising process before getting financing. You’ll also need to know what kind of financing you need to obtain, impacting which lenders you use. Be sure to include your legal and financial advisors at every step to ensure your personal and business interests are protected.