Franchise Financing Strategies for New Owners in 2024

If you’re like most new entrepreneurs, finding the financing to start your business can be challenging. Financing covers key expenses such as franchise fees and the initial costs of setting up operations. These costs can be pretty hefty, but don't let that scare you off.

With some smart financial planning, you can make your franchise dreams a reality. This usually means getting a loan, since not many people have that kind of cash lying around. Financing often involves a combination of different funding sources to come up with the necessary capital. 

1851 Franchise spoke with Paul Bosley, managing member of Business Finance Depot, for some insights into his recommended franchise financing strategies.

The Best Ways for New Franchise Owners To Get Financing  

As a franchisee, you have various options at your disposal — each with its own set of advantages and considerations. One common avenue for franchise financing is through the franchisor directly or via preferred lenders affiliated with the parent company. This can streamline the process and provide you with access to funding tailored to the franchise model.

“The more established franchisors typically have vetted different companies that they recommend,” Bosley said. “That’s the most common process. Newer franchisors learn that they can't get involved with the financing end of it because they're selling a franchise and making money directly.” 

If you can’t get funding through the franchisor, you still have other options available. ADP, an HR and payroll company, recommends financing your franchise through a commercial bank loan. However, banks can tend to be picky about who they lend to, so you'll really have to show them that your franchise idea is a winner. 

The Small Business Administration (SBA) offers another option for getting startup cash for your franchise. The SBA 7(a) Loan Program offers loans that are backed by the government, which means they usually come with better interest rates and payment plans compared to regular bank loans. 

Other franchise financing options include: 

• Alternative Lenders: Offer faster approval processes, but often come with higher interest rates and shorter repayment periods.
• Personal Assets: Can include tapping into savings accounts, severance packages, home equity or retirement savings plans, but may jeopardize long-term financial security.
• Rollovers as Business Startups (ROBS): Involves using retirement funds to kickstart a new business, subject to strict regulations.
• Crowdfunding: Utilizes online platforms to gather funds, but requires convincing investors and meeting fundraising goals.
• Friends and Family: Offers access to funds with lenient terms, but risks straining personal relationships if the business faces challenges.

How New Franchisees Can Plan Their Finances Effectively to Secure Financing

As a new franchisee, you will need to effectively plan your finances to secure financing. According to Bosley, credit scores (both yours and those of your partners) are an important determinant.

“Anybody that's going to be a partner that owns more than 20% of the company will be asked to sign on the loan, which means, at some point,the lender is going to pull their credit,” Bosley said. “So generally speaking, and this is just a rough guide, 700 is what creditors are going to consider acceptable.” 

You will also need to assess the total amount required to open the franchise, which is typically disclosed in the franchise disclosure document (FDD) provided by the franchisor. You should aim to have 20-25% of the high-end estimate available as partnership equity. 

“You have to have that money available and the way you demonstrate that, initially, is on your personal financial statement, which lists your liquid assets and your other assets and liabilities,” Bosley said. “So, identifying the liquidity that you're going to be able to use for your equity injection is important.”

While options like tapping into retirement accounts or using home equity loans exist, repayment must come from separate income sources rather than the franchise itself to avoid increasing business debt. Similarly, if borrowing from a 401(k), repayment must come from external income sources, not business revenue.

Collateral is typically required by lenders, often in the form of a house. Loans under half a million dollars may not require collateral, but most lenders will still ask for it.

Challenges To Watch For 

New franchise owners often encounter challenges in finding lenders willing to finance startups due to the higher failure rate compared to established businesses. Vetted lenders who finance startups are scarce, making it difficult to secure financing. Utilizing the FDD is crucial, as it outlines the cost range and the number of existing franchise locations, which reputable lenders often consider.

“When you're financing a franchise, the best tool you have is the FDD,” Bosley said. “Somewhere in the first 40 or 50 pages, it's going to tell you, not only how much it's going to cost to open up the franchise, but it's also going to tell you how many franchises there are.”

The FDD also lists how many of them have closed, how many of them have changed hands and how many of them are still open. Bosley noted that, realistically, established lenders are looking for around 5% or less to have closed.

Overcoming these challenges may involve seeking assistance from specialized companies with expertise in franchise financing, which can provide tailored solutions and support to ensure the success of the franchisee.

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

• How to Qualify for an SBA Loan
• SBA Franchise Loans: What They Are and How to Get One
• Franchise Financing 101: Finding and Securing Available Funds