Business Finance Options for Franchisees
During the COVID-19 pandemic, with record job loss, the United States began experiencing an unprecedented spike in entrepreneurship. The U.S. government reports new business formations based on applications for tax registrations, which began to surge in 2020. In fact, the U.S. Census reports 59,490 business applications in 2020 — an almost 42% year-to-year increase. Whether you’re looking to be your own boss mid-career or are pursuing a planned retirement job, purchasing a franchise with an SBA loan makes sense for many. First Business Bank’s SBA Lending team has helped many entrepreneurs become franchise business owners. Certainly, it takes pre-planning, research, and resources, so here are some important points about purchasing a franchise to consider well before diving into the transaction.
What Is A Franchise?
The International Franchise Association describes franchising as “a method for distributing products or services involving a franchisor, who establishes the brand’s trademark or trade name and a business system. The franchisee pays a royalty and often an initial fee for the right to do business under the franchisor’s name and system.” Buying in to a franchise allows you to work for yourself without starting your own business from scratch. As a franchisee, you own a business with specific goods or services, a proven operation process, and a familiar name and brand.
Why Consider Buying A Franchise?
To evaluate whether to buy a franchise, it’s important to know exactly what you’re getting with the specific business. Here are a few general advantages of franchises that you might not get starting a business from scratch:
Many franchisors offer manager help, which can be an invaluable resource and allow you to avoid missteps that might otherwise happen if you were starting your own business from the ground up.
Trusted products and services
Businesses that offer franchises often are already well known and have local, regional, or national customers. Trusted relationships with suppliers, lenders, and potential employees already exist, saving time and money, and mitigating the potential risk of finding and developing these contacts.
Bulk buying power
While you are often restricted to buying specific inventory, ingredients, or products from common vendors, you also benefit from lower prices that come with group purchasing power.
Franchises also often come with time-tested systems — point-of-sale, communication, billing, and more — that take the guesswork out of selecting from a sea of vendors for specific processes.
Expert marketing & advertising
Starting a business (that’s not a franchise) often requires significant start-up advertising and marketing costs to attract customers. As a franchise owner, part of your franchise fees may go toward a professional regional or national advertising campaign handled by the corporate business. The franchise business often consults with you if you want to advertise locally.
What Are Some Drawbacks Of Franchises?
Fees & business costs
Depending on the franchise business, you might have to pay advertising fees, franchise fees, and royalty fees on top of routine business costs. Non-refundable franchise fees are a one-time payment that can range from a four to six figures or more. You should also investigate the funds it might take to build, renovate, or rent a space. And you’ll need to account for equipment, inventory, licenses, and insurance. Royalty fees are ongoing, often a percentage of your income, paid for using the franchise brand name. Even if you aren’t making a lot of revenue, you’ll still need to pay royalty fees. Sometimes, advertising fees are pooled for the benefit of franchises. Investigate how much of these fees are spent on administrative tasks and if you can have any say about how the budget is spent. It’s important to know if the franchise only buys national advertising, regional advertising, or are they only spending advertising dollars on getting more franchisees?
Lack of control
Corporate offices of franchise businesses usually make many decisions about its franchise businesses, including appearance of your physical business inside and outside. You may have to budget to maintain these standards. They also restrict what you can sell and usually aren’t open to modifications. Operational restrictions may dictate how you run the business, vendors you purchase supplies from, how you hire employees, hours you operate, signage you use, and uniforms your employees wear. You may be restricted to a specific geographic area, which may or may not be very profitable, and you might not be able to choose the location.
Franchise contracts run a specified length of time with no guarantee to renew. If your contract is renewed, you can be subject to increased fees and more restrictions under the new contract.
Selecting a franchise business
Like any business you might start, you’ll naturally be more successful at a franchise business if you’re experienced in the business or passionate about it. Even with all the training franchisors offer, it’s a large commitment to be miserable owning a franchise. The International Franchise Association, the Small Business Administration (SBA), and the Federal Trade Commission have valuable information about selecting a franchise available in your area. After narrowing it down, carefully review of the franchisor's Uniform Franchise Offering Circular (UFOC), which contains information the franchisor is required by law to provide you before you sign a contract. Also make sure to contact other franchisees and the Better Business Bureau to check out the franchisor's credibility. You’ll want to start this journey with a trusted group of advisors; consider a lawyer, accountant, and an SBA loan specialist to start.
SBA loans for franchises
To encourage business growth, the Small Business Administration created SBA loans, which offer many advantages to many business owners, including those buying franchises. SBA loans are arranged through banks and a large portion is backed by the federal government, which allows banks to take on a client that might have a lower credit score, less collateral, or little experience. A few of the most important things to keep in mind when you’re choosing an SBA lender to fund your franchise acquisition are:
Is the bank an SBA Preferred Lender or do they just dabble in SBA loans? SBA Preferred Lenders have proven to the SBA that they are experts in navigating the complex system and facilitate the loan process as smoothly as possible for their clients.
Where there’s a will, there’s often a way. You want an SBA lender on your side who has the experience and has seen out-of-the-box financing and other modifications with SBA loans who can help you pivot if something doesn’t line up correctly.
Can you count on a whole SBA team at the bank to help you if someone is out? Is there regular communication about expectations surrounding the complex SBA process? You don’t want to be left out of the loop when documents are due or you have a pressing question for your banker.
Benefits Of SBA Loans
The most common SBA Loan is the 7(a) loan, which is also often used to purchase a franchise. SBA 504 loans often are used to buy commercial real estate for your franchise. These SBA loans offer:
- Lending limit of $5 million – often plenty to acquire a franchise business
- Longer repayment terms than conventional loans — 10 years for equipment, seven years for working capital, and 25 years for real estate
- Lower interest rates, potentially saving you thousands of dollars over the lifetime of the loan
Some franchise buyers use SBA Express loans, which have a lending limit of $350,000 and are faster to obtain — sometimes in 30 to 45 days. An SBA Preferred Lender, First Business Bank’s SBA team has a track record of helping businesses fund their SBA loans quickly. During the COVID-19 pandemic, when business innovation has skyrocketed, the team helped one buyer in record time. The team prioritizes client service, which leads to repeat franchise clients.