Ask a Consultant: What’s the Best Way to Get Financing for a Franchise?
Question: What are the best practices for financing a franchise?
A: The Franchise Information Document (FDD), which the franchisor is required to provide to potential franchisees, will include a specific section entitled “Estimated Initial Investment”. This section describes a range, depending on location and other factors, for opening a business under your franchise agreement. Keep in mind that you will also have a few unknowns and a learning curve, so add 20-30% to the number in the investing section to give yourself a cushion and a realistic financial goal.
Once you know the total amount, the decision is how much free cash (equity) you can contribute to the business. A good guideline is 30% of the investment required.
This leaves a 70% gap to be filled with bank financing or other source. Your franchisor may have a list of lenders they have prequalified who are predisposed to lend to their franchise community, so start with the franchisor’s list of approved lenders.
Your next source is national lenders specializing in franchise loans. These lenders are usually large banks that have franchise lending services, such as Wells Fargo, Bank of America, and Bank of Montreal (BMO).
Your best option may be your local bank, where you already have a personal relationship, however. Your bank will review your business plan to understand your franchise concept and how you plan to operate it. In many cases, local banks will implement a process to qualify your loan as a Small Business Administration (SBA) loan. The SBA has extensive knowledge of franchise concepts and provides your bank with an SBA guarantee.
Besides financing, there are two other important considerations: 1) make sure that you are operating your franchise business in a separate legal entity for personal liability protection, and 2) when you usually cannot avoid personal guarantees. to your lender (especially SBA loans), try to limit collateral by burning them down as your franchise business matures.
Fortunately for new franchisees, the franchise business model is well understood by the lending community. The same due diligence that you put into researching your concept should go into finding the perfect loan partner. Franchising, after all, is all about relationships.
Dennis Monroe is a distinguished fellow of the Faculty of Law at the University of St. Thomas, and co-founder and president of Monroe Moxness Berg PA. This is the second part of a four part series on franchising.