Franchise Financing – All Your Options and How to Qualify
Purchasing a franchise is a choice to invest in your future. This decision comes with huge opportunity and the potential for a more fulfilling, more rewarding life. And yet, most entrepreneurs don’t have the liquid capital available to buy a franchise outright. Franchise financing and leveraging debt is a common solution to the getting-started capital issue to help franchisees realize their dream of business ownership.
With several franchise financing options available, many future business owners find suitable funding for the launch of their new businesses. Of course, detailed research is essential when making such an important financing decision. To help you along the way, we’ve collected some of the most useful franchise financing information available to help you examine your options and make the decision that will drive your exciting future.
The Big 3 Franchise Financing Options:
Small Business Administration (SBA) Loans
Rollovers for Business Startups (ROBS)
Home Equity Line of Credit (HELOC)
SBA loans are a popular franchise funding option and can offer up to $5 million to the borrower.
An SBA loan is a loan that is partially guaranteed by the Small Business Administration (SBA). This guarantee allows lenders to offer loans to small businesses that may not qualify for traditional bank loans. The SBA does not actually lend money to small businesses, but instead guarantees a portion of the loan amount, which reduces the risk for lenders. SBA loans can be used for a variety of purposes, including working capital, equipment purchases, real estate, and refinancing existing debt. The interest rates on SBA loans are typically lower than those of traditional bank loans, and the repayment terms are longer.
Types of SBA Loans
The SBA offers several loan programs to meet the needs of different types of small businesses. The most common types of SBA loans are:
7(a) Loan Program: This is the SBA's primary loan program and can be used for a variety of purposes, such as working capital, equipment purchases, and real estate. The maximum loan amount is $5 million.
CDC/504 Loan Program: This program is specifically designed for businesses that want to purchase or improve commercial real estate or purchase major fixed assets. The maximum loan amount is $5 million.
Microloan Program: This program provides small loans of up to $50,000 to help small businesses with startup costs, working capital, and inventory.
Disaster Loan Program: This program provides low-interest loans to businesses that have been affected by a natural disaster.
Qualifying for an SBA Loan
To qualify for an SBA loan, you must meet the following criteria:
Be a for-profit business that is officially registered and operates in the United States.
Have invested your own time and/or money in the business.
Have exhausted other financing options, including personal assets.
Have a strong credit score (typically 680 or higher).
Demonstrate the ability to repay the loan, including providing financial statements and a business plan.
Meet the SBA's size standards, which vary depending on the industry.
Additionally, the SBA may require collateral for the loan, such as personal assets or real estate, and may require a personal guarantee from the business owner(s). To apply for an SBA loan, you will need to work with an approved lender who participates in the SBA loan program. The lender will review your application and submit it to the SBA for approval. The SBA may also require additional information or documentation during the application process.
A Home Equity Line of Credit (HELOC) is a type of loan that allows homeowners to borrow against the equity in their homes. Those with significant home equity available (the market value of a home, minus the amount owed on the mortgage loan) may find this a viable way to fund portions of a new franchise. HELOC funds typically come at a higher interest rate than an SBA loan and it could be risky to leverage your home for a business. On the other hand, HELOC funds do not need to be used once approved and can serve as a useful pool of financing on an as-needed basis or as a down payment on an SBA loan.
What is a HELOC?
A HELOC is a type of revolving credit that is secured by the equity in your home. With a HELOC, you can borrow up to a certain amount, called your credit limit, and you only pay interest on the amount you borrow.
The repayment terms for a HELOC vary, but typically you will have a draw period of 5-10 years during which you can borrow money, followed by a repayment period of 10-20 years during which you must repay the amount you borrowed plus interest.
Determine your credit limit: Before you can use a HELOC to buy a franchise, you need to know how much you can borrow. Your credit limit will be based on the equity in your home, your credit score, and your debt-to-income ratio. You can typically borrow up to 85% of your home's equity, but this varies by lender.
Apply for a franchise loanm: Once you've found a franchise you're interested in, you can apply for a franchise loan (perhaps a common 7 (a) SBA Loan as mentioned above). You can use your HELOC to fund the down payment on the loan or to cover any additional expenses associated with the purchase.
Repay the loan: Once you've purchased the franchise, you'll need to repay the loan according to the terms of the loan agreement. You'll also need to make payments on your HELOC if you borrowed money to fund the down payment.
A ROBS, or Rollovers for Business Startups, is a financing option that allows entrepreneurs to use their retirement funds to start or buy a business, such as a franchise. A ROBS allows you to access your 401(k) or IRA account without any IRS penalties. Of course, you risk your retirement savings in doing so, but many find this a valuable investment. While your 401(k) or IRA funds may not be gaining interest when moved into a ROBS plan, there is potential to grow the investment more than the money market ever could.
What is a ROBS?
A ROBS allows entrepreneurs to use their retirement funds, such as a 401(k) or IRA, to start or buy a business. With a ROBS, you can roll over your retirement funds into a new 401(k) plan, which is used to purchase stock in new business: yours! The money in the new 401(k) plan is then used to fund your own business.
The main advantage of a ROBS is that it allows you to use your retirement funds to start or buy the franchise business without incurring early withdrawal penalties or taxes.
Using a ROBS to Buy a Franchise
If you're interested in buying a franchise, a ROBS can be a useful tool for financing the purchase and it is commonly done in the industry. There are currently two main lenders in the U.S. that facilitate the ROBS program to fund your franchise business: Benetrends and Guidant.
When you work with these provider companies they will do all of the administration to facilitate the ROBS for your business and will take these steps to help you use ROBS to buy a franchise:
Set up a C-corporation: To use a ROBS to buy a franchise, you need to set up a C-corporation. The C-corporation will issue stock, which you'll purchase using your retirement funds.
Set up a new 401(k) plan: Once you've set up your C-corporation, you need to set up a new 401(k) plan. You'll roll over the funds from your existing retirement account into the new 401(k) plan.
Purchase stock in your C-corporation: Once you've set up the new 401(k) plan, you'll use the funds to purchase stock in your C-corporation.
Use the funds to buy the franchise: The funds in the new 401(k) plan can then be used to buy the franchise directly or as a downpayment toward an SBA 7 (a) Loan, for example.
Repay the 401(k) plan: Once the business is up and running, you'll need to repay the 401(k) plan according to the terms of the plan. This usually involves making regular payments over a period of time.
Qualifying for a ROBS
To qualify for a ROBS, you must meet the following criteria:
Have a retirement account: You must have a retirement account, such as a 401(k) or IRA, that you can roll over into a new 401(k) plan.
Have a good credit score: While a good credit score is not a requirement for a ROBS, many lenders require it to approve a loan associated with the ROBS.
Have a viable business plan: You'll need to have a viable business plan for the franchise you want to purchase. Many franchisors, like Glosshouz Spa Center Franchise business, can help you with this.
Meet other lender requirements: Each lender has its own set of requirements, such as minimum income and employment history.
Work with a ROBS provider: To set up a ROBS, you'll need to work with a ROBS provider. The provider will help you set up the C-corporation and the new 401(k) plan.
Final Thoughts on Franchise Financing
Several companies are known for funding new franchisees. Consider exploring each of them, as well as friends and family loans. Lenders typically evaluate a variety of information when determining your rate, term, and qualification status. These documents include your credit score, recent financial documents, your business plan, the business’s financial projections, the business license, applicable professional licenses, the business’s articles of incorporation, the business’s partnership agreement, your driver’s license or other photo ID, your professional resume, and more.
When it comes to your professional future, don’t let financing get in the way. Your investment in a new franchise could be the move that changes your life and creates a legacy for your family. Research your options, meet with finance professionals, and run your own destiny.
Glosshouz USA has established relationships and contacts with a number of established franchise business lenders. Ready to learn more about franchise ownership with Glosshouz? Get in touch for a no-commitment conversation today!