Loan Expectations for First-Time Franchisees
If you are seeking franchise business financing, some things may surprise you as a first-time franchisee. Since franchisors require an initial investment to secure their rights, the initial, up-front pricing may be a challenge to secure.
It is true that certain types of business actually can get free or low-cost start-up funds. Grants might be available, though unlikely, and the Small Business Administration coordinates with pre-approved lenders to assist businesses with the initial funding of new, small businesses.
Unfortunately, business loans can take a toll on fresh-faced and excited entrepreneurs. Any lender will expect sacrifices from you, so prepare yourself for some intrusive requests. Evaluate your tolerance levels for each as you ink your first start-up loan. One way or another, you will be expected to accept some or all of these requirements.
Financial Strength
A bank expects you to pay them back, so you have to prove that you are a worthwhile risk to them. This means either cash reserves or evidence of prior success. Do you remember how, as a youth, you couldn’t get a job without experience, but you couldn’t get experience without a job? Well, welcome back. If you had the cash, you wouldn’t need the loan, and to get the loan, you need proof that you either have the cash or that you have successfully run a business before.
Eggs in Different Baskets
Lenders will also not expect the business to repay the loan. Yes, that’s your plan. Yes, that seems to make sense, but the lender wants the money back even if your business bombs. For you, this means that repayment must be available from another source like investments, cash, or a partner’s income. Don’t be surprised when the risk evaluation is not solely dependent on your anticipated, but as-yet-unproven, revenue.
Personal Guarantees
Corporate law allows many ways to protect your personal property from business failure. So, what will a lender do for untested entrepreneurs? They will get around that by requiring a personal guarantee that you (and your spouse in a community property state), will have to sign if you want the loan. A personal guarantee is just that: you are fully and wholly responsible for the loan, even if it takes years to pay off after you sell or close a business. Of course, your plan is positive, but the bank plans for the worst.
Liens
If cash, credit, and other income streams are not available, lenders will look for collateral by putting a lien on your real property. This could be a lien against your car, your house, or anything of value that gives them a security interest. This won’t disrupt those collateral items. But, if you default on loan payments, a car, or house cannot be sold without first making good on the original franchise loan.
Don’t be dissuaded. Franchises work because franchisees are dedicated and utilize their new company’s resources to succeed. But, as you consider business loan financing, don’t be surprised at some demanding requests from lenders. If you prepare yourself for this step in the new franchise process, you can then plan for your new franchise success
How Bad Credit Impacts Your Ability to Buy a Franchise
One of the biggest considerations a franchisor makes when examining a prospective franchisee is how successful that person will be in business. There are many factors that are taken into account when making that decision, and one of them is your personal credit history.
A bad credit score isn’t an automatic denial. It just means that you might have to go to a few more hoops to get through their system and get the franchise of your dreams. Here are a few of the challenges you could encounter along the way that will determine your ability to buy a franchise.
You Could Struggle to Get a Loan or Lease
When you buy a franchise, you might need a small business loan to finance your new venture. If you’re not buying a home-based franchise, you might also need a lease for the facility where you set up shop. Getting the loan or a lease could prove difficult if you don’t have good credit.
To show the franchisor that you’re able to get a loan and establish your physical roots, it’s a good idea to create a rock-solid business plan, and showcase that you’re able to get the financing you need up front. If you’re still not able to get a loan, it’s important that you disclose this to the franchisor. When you’ve done the hard work, there may be other options available outside of traditional financing plans.
You Might Pay a Higher Interest Rate
Sometimes, a bank will give you the loan you need to finance your franchise, but you might encounter a higher interest rate. In this case, you’ll be required to pay higher monthly payments.
As you evaluate the franchise offer, look closely at what your estimated monthly costs and revenue will be. Although the interest rate and monthly payments might be higher, the investment could still prove profitable in the long run.
You’ll Need a Strong Startup Plan
Some franchises take root and are immediately positioned for success simply because the brand is so well known and the demand is so high. Others take some time to get off the ground.
If you have bad credit, ensure that you’ll be able to meet your monthly payments by evaluating the costs it’ll take to start, as well as how quickly you anticipate making money. To estimate this, it’s a good idea to take a pulse of what’s happening in your target market and talk to other franchisees who have recently bought the same franchise. These insights can help you gauge what to expect so that you avoid falling further into debt or hurting your credit.
Yes, You Can Buy a Franchise with Bad Credit
If you know you have bad credit, you might have to go through a few extra steps to buy your franchise. Still, it’s possible. Bad credit isn’t an automatic denial. By creating a plan and showcasing that plan to the important parties in your franchise ownership, you can set yourself up for success now and long into the future.
7 Questions to Ask Before Financing Your Franchise
Not everyone has tens of thousands of dollars sitting around in their bank account, waiting to be invested in a franchise. If that’s the case for you, don’t assume you can’t become a franchisee because you don’t have the startup capital…yet.
You’ve actually got several options when it comes to franchise financing. To figure out which is right for you, ask yourself these questions to get started.
1. What is My Budget (Both Business and Personal)?
Certainly, you know how much the franchisor requires for your initial franchise fee. But you will need to budget for business expenses like a real estate lease, business licenses, overhead, inventory, and payroll as well. Also remember that you will also need to cover your own salary in your budget, as well as plan for unforeseen expenses.
You’re not guaranteed to make a profit in the first months of launching your franchise (in fact, your goal should simply be to break even), so build your budget for the first year, and include any and all expenses, including paying yourself. The last thing you want is to have invested so much and then run out of money, forcing you to sell or shut down your franchise.
2. What is the Estimated Time to Profitability?
While there’s no exact timeline for becoming a profitable business, you can at least get a sense of how long it should take based on other franchisees’ experience. Talk to as many as possible so that you can build your budget accordingly.
Because you will be saddled with a business loan for the foreseeable future, it’s important to get it right. Spend time assessing your options and even comparing banks or lending programs to ensure the option you choose fits your needs.
3. How’s My Credit?
If you’ve got a good credit score, you should have less difficulty getting approved for a small business loan. If your credit isn’t that great, start working on rebuilding it now so that in a year or two you’re better positioned. If you do plan to take out a loan, gather all your financial documents, including personal financial statements, to make the loan application process go smoother.
4. Do I Have Money in Savings?
If you do, fantastic. If you don’t want to take out a loan, start setting money aside now and project when you’ll be ready to take the plunge. Also consider temporarily borrowing from your retirement fund, but only if you can promise yourself, you will pay it back long before you plan to retire.
5. What is My Net Worth?
Related to credit and savings, one of the criteria a potential franchisor will assess to determine if you’re a good fit for becoming a franchisor is your net worth. Net worth refers to the balance of your assets and liabilities at one point in time. In a basic sense it is your sources of wealth minus the debts you owe.
What this number tells franchisors is how well you manage money—and how successful you will be managing your franchise’s money.
If you have a high net worth, this tells a franchisor that you can be a bit careful about the opportunities you pursue, and they’ll want you all the more.
6. What are My Financing Options?
Not every new franchisee has the funds to fully outfit a new business, and even if they do, it’s often still a good idea to take out a loan to conserve cash. There are several financing options to consider, depending on your credit profile.
- Franchisor Funding: Your first step should be to ask your franchisor if they offer any in-house financing. Some might offer funding for a portion of the franchise fee or funding to purchase or lease equipment. Some may have a partnership with third parties to provide franchisee financing. But just don’t automatically choose it, however. First see how the interest rates compare to other loans, and then make your decision.
- Line of Credit: Another option is taking out a line of credit with your bank. This gives you access to cash when you need it, rather than getting a lump sum up front.
- SBA Loan: You may want to consider an SBA loan to finance your new franchise business. The Small Business Administration (SBA) works with banks to offer low-interest rates for business owners and franchisees.
7. Would I Want to Answer to Investors?
If you’re looking at taking on an investor to get a cash injection, realize that means the investor will own equity in your company, and therefore will have a say in some of the business operations.
If you don’t mind having a partner, by all means, consider this route. Or if you want an investor with limited power, make sure you outline what you’re willing to give up in terms of control at the start of the conversation.