Franchise opportunities are on the rise, with more than 3,100 franchise concepts available in almost 300 industries. The International Franchise Association indicated, in its Franchise Business Economic Outlook for 2015 report, that the number of U.S. franchise establishments is projected to increase.
“With the rise in franchise opportunities, there’s an increase in financing to support the franchise concept, including through the U.S. Small Business Administration (SBA),” says Romona Davis, vice president of SBA commercial lending at Ridgestone Bank.
Smart Business spoke with Davis about franchise financing and how SBA loans fit in.
Why do people purchase a franchise?
Franchising is looked at as a way to start a business that already has a track record. There’s usually brand recognition, assistance with site selection, training, R&D of new products and services, off-site marketing assistance, and overall guidance and support from the franchisor and other franchise owners. It can be viewed as a team approach.
Do franchisors provide the debt financing?
Some franchisors carry the entire debt financing per franchise owner, while others carry a fraction of the loan through a franchisor-owned finance company.
Many franchisors still don’t offer financing but work directly with companies or mediators who specialize in securing financing for their prospective franchisees. Mediators typically provide assistance with business plans and packaging of potential franchise opportunities for submission to banks, nonbank lenders and other funders.
Where does the SBA come in?
The SBA can be a valuable resource for franchise financing. An SBA loan through a bank or nonbank lender provides a loan guarantee up to 85 percent. In addition to the loan guarantee, the SBA provides other guidance as it relates to franchise financing.
The SBA has a franchise committee that reviews existing franchise brands. This review covers the franchisor’s business operations, the agreement governing the franchisor/franchisee relationship and other related documents. The results are compiled in the SBA Franchise Registry. Not all franchises have been reviewed by the SBA; therefore, be sure to obtain a copy of the Franchise Disclosure Document (FDD) — presented to buyers in the presale disclosure process — along with the Franchise Agreement for further review by your bank.
The SBA loan guarantee also can offer a lower down payment and longer loan term with no balloon payment. In the event a franchise concept has limited hard assets (i.e., service company), the SBA loan could mitigate the proposed collateral shortfall.
What do business owners need to know before investing in a franchise?
Franchising is a contractual relationship. The brand owner doesn’t manage or operate its locations. However, the franchisor does allow the business owner to use the licensor’s brand and method of doing business to distribute products or services to consumers.
The franchisee pays the franchisor an initial upfront fee to acquire the franchise as well as an ongoing royalty fee. Training and support is provided by franchisors.
Franchising can offer peer support and networking. Each franchisee has an exclusive territory, so cooperation is not only possible but also built into the business model through annual conferences, regional meetings, websites, etc.
All prospective franchisees should review the FDD. This legal document provides the history of the franchisor, ownership, types of franchises offered, business experience, litigation, financial performance and more.
From a financing perspective, lenders desire applicants with experience and/or transferrable skills in the franchise-related industry, a 20 to 30 percent down payment, adequate personal credit history, a detailed business plan and projections that demonstrate the ability to repay the loan.
What else would you recommend?
Research multiple franchise brands. Once you’ve identified a prospective brand, conduct a thorough examination prior to contacting the franchisor. Then, interview the franchisor and follow up with its references. Once you’ve finalized your decision, meet with your banker to see if you qualify for SBA financing — to make your dream a reality.
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