Financing Your Franchise Expansion

Expanding a franchise requires capital, and securing financing is often a crucial step in the process. Franchise owners need funds to fuel growth, whether they're opening new locations, upgrading their equipment or investing in marketing efforts.

To shed some light on the financing avenues available to franchisees, 1851 Franchise spoke to Reg Byrd, president of SBA & Bank Financing at Benetrends Financial. Here's an overview of the financing options and key insights to help franchise owners make informed decisions aligned with their business goals and financial capabilities.

Financing Options

Franchise owners on a budget have several financing options at their disposal, each with its own pros and cons.

1. SBA (Small Business Administration) Financing: The 7(a) Loan Program, administered by SBA, provides loan guaranties to lenders that allow them to provide financial help (with special requirements) to small businesses.

"The SBA insures the money that banks lend, so the banks are the ones lending the money,” Byrd said. “Your relationship will be with the bank, but the bank has obligations that they need to adhere to that the SBA sets forth."

Typically, SBA loans offer favorable terms and lower interest rates, making them an attractive option for franchise expansion.

2. ROBS (Rollover for Business Startups) Transaction: Franchisees have the option to utilize ROBS, which allows them to use retirement funds tax- and penalty-free for financing. This includes the 401(k) rollover and the ROBS transaction, providing injection money for SBA loans or other financing needs.

3. FinTech (Financial Technology) Online Banks: Online banks in the FinTech sector offer alternative financing options, particularly beneficial for startups or when traditional SBA loans are not feasible. However, interest rates and terms may vary, often resulting in higher rates compared to SBA loans.

“If you go FinTech you're likely going to pay a higher interest rate,” Byrd said. “The terms are usually not as favorable as an SBA loan. I'm not saying that's the case all the time, but that's the case that I've seen over and over again."

4. Equipment Financing: Franchise owners also can opt for equipment financing, which is ideal for replacing equipment, furniture and fixtures. This type of financing can complement SBA loans or serve as an alternative path for franchisees seeking capital.

5. Marketable Securities: Franchisees can leverage marketable securities, such as stocks and bonds, as collateral for loans. Similar to SBA loans, securities-backed loans typically offer favorable terms and conditions for financing.

“You can use your securities as collateral, basically, to secure funding,” Byrd said. “So the bank will put a lien, so to speak, on your marketable securities and then be able to lend you money similar to an SBA program. The terms are usually pretty favorable."

6. Equity Financing: Franchisees can explore leveraging equity in their home or other assets for injection money or as collateral for financing. However, they should exercise caution to avoid depleting all of their equity.

“Once you take equity out of your home, you're spending your liquidity, your part of your net worth,” Byrd said. 

7. Friends and Family: Partnerships with friends and family may also be considered, although eligibility criteria must align with lender requirements. This is an attractive option for those who have poor credit ratings or can’t afford to pay interest, but it does stand the risk of negatively impacting personal relationships (especially if the venture isn’t successful).

The Importance of Financial Planning Before Expanding

Thorough financial planning is a crucial step when seeking expansion financing to help make sure that personal financial composition is strong and that the existing business is profitable. 

“The first gatekeeper I will always go back to is making sure that you are rock solid in your personal financial composition,” Byrd said. “We have to get that first gate open. That means if you own existing businesses, make sure that those businesses are profitable, and so forth. That's the best financial planning that one can do.” 

Understanding financial statements like profit and loss statements and balance sheets is also essential. Many business owners struggle to read these statements, leading to errors and inaccuracies. Before expanding, be sure to get these statements in order. 

“We have to coach and counsel folks a lot on what their balance sheet should look like,” Byrd said. “So, you need to get back with your accountant, or whoever's doing your books, and make some corrections with the profit and loss statement.” 

Potential Challenges of Franchise Expansion Financing

Franchise owners face unique challenges when seeking expansion financing. Lenders are typically more willing to lend to businesses that are already profitable and have a strong financial track record. This is because lenders want to be sure that the business is viable and has the potential to generate enough cash flow to repay the loan.

"This is something that comes up very frequently when existing business owners either have a franchise or another business that they've owned for years and years,” Byrd said. “But one of the things that we have to do as a lender — must do and will do — is audit or underwrite the last three years' financials for the existing business."

When auditing a franchisee’s financials, lenders usually look at factors such as revenue, expenses and profit margins. Lenders will also consider the franchise owner's personal financial composition, net worth, credit history and industry experience. This is because lenders want to make sure that the franchise owner is financially responsible and has the ability to repay the loan.

After lenders assess the franchise owner's existing business and personal finances, they will examine the business venture itself. They will look at factors such as the profitability of the franchise, the debt servicing capacity of the business and the debt capital ratio. Lenders will want to make sure that the business has the potential to generate enough cash flow to repay the loan.

Additional Tips for Franchise Expansion Financing

Here are some additional tips for franchise owners who are seeking financing for their expansion efforts:

• Work with a qualified franchise consultant. A franchise consultant can help owners develop a strong business plan and identify potential lenders.
• Build credit history. Lenders will look at the personal credit history of franchisees when evaluating their loan application.
• Save for a down payment. Lenders typically require a down payment of at least 10% of the total loan amount.
• Be prepared to provide collateral. Lenders may require owners to provide collateral, such as real estate or equipment, to secure the loan.
• Be patient. The loan approval process can take time, so franchise owners should be patient and persistent.

Securing expansion financing can be a challenge, but it’s definitely doable with careful planning and preparation. Franchise owners who are able to demonstrate profitability, strong personal finances and a viable business plan will be more likely to succeed in obtaining the financing they need.

To learn more about franchise financing, check out these related 1851 Franchise articles: 

• The 10 Best Options to Finance a Franchise Business
• Franchise Financing: 5 Smart Strategies for Investors
• Franchise Financing 101: Finding and Securing Available Funds