Financing is one of the most confusing, and often frustrating, aspects of opening a franchise. Some franchisees pay cash, others take out home equity loans or tap into their retirement savings.
In this article, we look at one of the most popular methods of franchise financing: the SBA Loan. SBA Loans are loans made by traditional lenders such as banks that are guaranteed by the federal government’s Small Business Administration.
Banks prefer to lend money to franchise concepts which they have a positive track record, so the best place to start is with your franchisor. The franchisor should be able to provide you with a list of lenders that are familiar with its concept, have made SBA loans to other franchisees and have a positive track record underwriting the concept. Some franchisors have a dedicated outreach program to educate lenders about their concepts. The majority of major franchisors also participate in the SBA Registry program. To appear in the registry, franchises must meet certain eligibility requirements and pay an annual registration fee. Franchisees of systems listed on the registry receive expedited loan processing when applying for SBA loans.
If you need help putting together a loan package, your franchisor should be able to assist you. While the franchisor won’t complete the package for you, they should be able to provide a template as well as suggestions on where you can find the information you need. The main aspect of the loan package will be a loan proposal or business plan. The loan proposal should provide a description of the business, profiles of management, the purpose of the loan and plans for repayment. The loan package will also need to include: a one year projection of income and expenses, a list and cost of equipment to be acquired with the loan, a personal financial statement and copies of tax returns.
Your franchisor should also be able to give you an honest appraisal of how likely it is that you will be able to obtain financing. Lenders look at several characteristics when determining whether or not they are going to approve a loan. The underlining principles of obtaining financing are known as “The Four Cs”
Character – Lenders will look at your credit track record. Do you pay your bills on time? Have you had any loans before? Did you repay them? The easiest way to get a handle on your Credit “Character” is to get a copy of your credit report. In today’s era of computer automation, this is the most important C. You will have a very difficult time getting approved for a loan unless you have a strong credit history.
Collateral – Lenders require you to pledge assets to secure the loan. These assets may be forfeited if you default on the loan. SBA loans require the assets of the business to be pledged as collateral. Many SBA loans also require additional collateral such as home equity or a certificate of deposit.
Capital – Lenders’ willingness to approve a loan increases as you put more capital into the business. That is, you are more likely to get approved for a loan for 60% of the franchise cost than a loan for 90% of the franchise cost. Lenders also look for additional capital that you can use as a cushion after you start your franchise.
Capacity – Lenders also examine the ability of your franchise to repay the loan. Obviously, if you anticipate your franchise will only generate $1,500 of net income each month, a bank is unlikely to make a loan that requires you to repay $2,000 a month.
In part two of our look at SBA Loans, we examine the specific provisions of SBA loans such as the interest rate, term and amount of financing.
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Click here to read Part 2
Jamie is founder of Smarter Franchise. Your source for franchise research, news and community. He is a previous owner of a major franchise and has a background in finance.
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