Setting up a franchise usually involves becoming a licensed agent of a larger business to sell its products or services. For instance, if you become a franchisee for an automobile company like Toyota, you will be able to sell Toyota cars through your dealership.
The franchisor is the person or the company that grants the license to the franchisee, specifying the products and services that will be offered by the third party under the trademark and trade name by the franchisor. As part of the agreement, the company whose products you are selling also provides pre and post sales support. When you become a franchisee, you get to be part of an established business and still conduct operations independently.
Much like a business partnership requires certain investment, franchising also requires money. A franchisee has to buy the franchise from the franchisor with a fixed amount of money.
In fact, buying a franchise is a popular form of investment, while also allowing the franchisee to become part of a renowned, established business. The franchisee gets the independence and flexibility of a small business owner and the infrastructure and support of a large company. It's one of the most preferred ways of starting a small business.
On the downside, as a franchisee, you have no control over larger business decisions (for instance, if the franchisor decides to withdraw a particular product) and you also have to bear the startup costs. Remember business start up loans are available for franchises.
If you don’t have the capital to cover franchise costs, you can seek franchise loans. A franchise loan provides you with the capital to buy a franchise and to cover the various costs associated with it.
What is a franchise loan?
A franchise loan works like any other loan, except that it's meant for buying or investing in a franchise. But before you get into a franchise loan, you must know the costs associated with becoming a franchisee. The most important of franchise costs are:
All franchisors charge a fee to the franchisee setup a franchise. This fee is usually paid by the franchisee upfront as a one-time payment or in installments.
The amount to be paid in franchise fees usually varies with the company, but generally, the bigger and more established a company, the higher the fees. Even if you buy a franchise in a smaller company, you have to pay tens of thousands of dollars in franchise fees.
However, do not mistake this fee as a security deposit or a refundable cost. The money goes entirely into the pocket of the franchisor, and you will never get it back. This isn't where the fees end, though. A franchisee also has to pay the following.
When an author writes books and allows a publishing house to sell the books and make money, the author charges a royalty fee for every book sold. Similarly, a franchisee has to pay a royalty fee or an ongoing franchise fee to be able to operate the franchised business.
This isn't a one-time fee. The franchisee has to pay the royalty fee every year, as a percentage of their gross revenue. The fee may also be a fixed amount, regardless of the revenue. On an average, the royalty fee is around 5 to 6 percent of the sales volume of the franchise.
But the fees are higher if the company is an established brand. Some franchisors charge as much as 50 percent of the gross revenue. Expect to pay fees that high if you become a franchisee of established businesses like Mercedes Benz or Dominos Pizza.
Aside from the above fees, most franchisors also make franchisees take part in a common advertising or marketing fund, and a fee is charged for this. This may either be a fixed amount, but may also depend on the revenue of the franchise.
Although this may seem unnecessary, you need to pay all of these fees as a franchisee. And when you add up all these costs, starting and running your franchise can be an expensive endeavor.
If you have enough money to bear the startup costs, you can pay the fees out of your own pocket. But if you don't have enough capital, but would still like to be a franchisee, then there are a variety of franchise loans that provide financing.
Franchise loan options
As with any small business, finding financing is the most challenging part about starting a new franchise. However, there are a variety of financing options available for franchisees. Some loan options are solely for franchises, while general small business financing options are also available to franchisees. Let's take a look at the options available to franchisees:
Ideally, the best place to start is the franchisor itself. Some franchisors, especially the bigger ones, often help finance new franchises. In fact, franchisor financing programs are usually the first place franchisees look for help with financing.
Franchisors may waive fees or partner with lenders to help franchisees secure loans. Sometimes the company may also offer to fund. However, before choosing a franchisor financing program, you must compare it with other options to find what is best for you.
There are some definite advantages of using a franchisor financing program. It is a streamlined process, where you get the money right away for starting the franchise. This program helps you pay for the hefty franchise fee, as well as the capital needed to cover other costs like running the business or buying equipment.
In fact, a franchisor financing program often helps pay for almost 75 percent of a franchisee’s total startup costs. Franchisors also have better knowledge about franchise financing than conventional lenders. The franchisor will always do a better job of accurately estimating the risks and underwriting the loan.
Franchise financing company:
There are several companies that specialize in franchise funding. These franchise financing companies either lend directly to the franchisee, or match borrowers with lenders. Some popular franchise financing companies in the US include BoeFly and Franchise America Finance since these companies have financed some very successful franchises in the past.
If your parent business is on the SBA Franchise Registry, then getting an SBA loan should be the easiest option for you. The SBA guarantees several loan types issued by banks, credit unions, and other lenders. As a franchisee, you might also want to consider both the 7(a) and CDC/504 programs.
Franchisees, as well as other small-business owners, can apply for an SBA loan through the lender. Applying for a franchise loan gets easier if the parent company is on that list because the SBA has already reviewed those companies and their franchise agreements.
The SBA doesn’t issue loans but rather helps franchisees secure loans at lower fees because SBA loans are partially guaranteed by the government. Even if the franchisee defaults on the loan, the lender doesn’t suffer a huge loss.
Banks and credit unions remain a primary source of financing for businesses. Of all small business loans, franchise financing constitutes over 20 percent.
Although any new franchisee can apply for a commercial bank loan, lenders are more likely to approve only franchises of an established, successful and renowned brand. Besides the parent company, the franchisee will also be subjected to the bank’s underwriting standards and lender’s policies.
Your credit history and net worth will be reviewed, and you will also need to have collateral, irrespective of the company you are a franchisee of. Read more: Can you get a business loan with bad credit?
How to qualify for franchise loans
There are a few things that are mandatory if you want to qualify for a franchise loan. Regardless of the type of loan you apply for, the following three things are consistent.
Your personal credit score
This is the single most important deciding factor for approval of any type of loan from a financial institution. Even if your parent business is reputed, even if it's listed in the SBA, your personal credit score still remains the most important factor, more critical than your business score. This will also qualify you for the best business credit cards.
Your personal credit score is a three-digit number, where 300 is the worst and 850 the best. The reason why your credit score is so vital is because lenders need proof of your reliability as a borrower when funding your franchise. Your personal credit score is the most solid proof of your trustworthiness.
If your credit score is good, lenders believe that you are responsible with your personal debts, and will also be responsible with your business debts. With a poor credit score, it is hard to get any loan, including franchise loan. In fact, with a credit score under 500, it is hard to get a franchise opportunity at all.
Before you apply for the loan, make sure to organize your financial documents needed to secure the loan. You will need to put together a personal financial statement listing your assets and liabilities, net worth, and personal income. Lenders require your financial information to find out how good you are at managing your finances. The documents needed are:
Balance sheet: From your personal balance sheet, lenders get an idea of what you own and what you owe, and learn more about your assets and liabilities. Assets include cash on hand, savings accounts, vehicles, property, bonds and securities, and other assets. Liabilities include your current bills, loans, mortgage, etc.
Income statements: The lender also requires your income statements to be able to verify your source of income, because they need to know where your money is coming from and going to. Lenders will not only look at your income but also at how you spend money.
This is another way to find out if you are responsible with your personal finances because if you handle your personal finances well, you should also handle your business finances properly. There is just a greater chance in that being so.
Because this is a franchise loan, you also need to provide a solid business plan aside from your credit rating and personal financial information.
The business plan could make or break your chances of getting approved for the loan. A thorough business plan includes a study of the business you are about to start, estimates of working capital, a solid marketing plan, revenue projections and cost analysis, and proof of your skills as a business owner.
Things to know
Getting any kind of loan, including a franchise loan is a time-consuming process fraught with difficulties. With so many factors determining your eligibility, you need to be extra careful when applying for a business loan.
Although your personal credit, business history, and trustworthiness are some of the most crucial factors, the following tips can make the process a little easier for franchisees.
Find out the collateral required
Remember that a franchise loan is a secured loan, which means you have to put up collateral. Before you apply, check the assets you own and calculate how much you are willing to put up as collateral.
Businesses that have plenty of assets to provide 100 percent collateral have a higher chance of getting the loan approved compared to those with lower levels of collateral.
The assets that you put up as collateral could be anything, from stocks, property, home equity, to cash deposits or savings and business inventory. However, remember if the business fails, the lender has the full right to take the collateral.
Get an SBA-approved target franchise
Loan applications from franchises listed in the SBA registry are usually processed faster because the SBA already has the information required about the franchise. When choosing a business to franchise, always choose one that is SBA-approved.
Count on a sound reputation
If you are a franchise of a highly renowned and reputable business, getting financing becomes a lot easier. Many lenders usually short-list the franchise businesses they have worked with successfully without any problem.
These types of franchises have an easier time getting approved for financing. You may also ask the franchisor to introduce you to lenders that are more likely to accept your loan application.
Starting any business is serious a challenge, but knowing how to get financing for your franchise business makes things easier and helps you start off on the right foot.
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