Navigating the Waters of Franchise Lending

As an entrepreneur, franchise ownership gives you the advantage of operating a business with brand recognition, operating procedures, and a demonstrated history of performance. You get to skip those early days and long nights of starting the company in your garage—and all the frustration and fear that comes with it. The franchisor also acts as a supporting guide to assist the franchisee toward a positive outcome.

But by mitigating the risks of the seed and development stage, it also means you are giving up a certain element of control. Franchisors may ultimately determine the business location, as well as the design and appearance, the types of products/services you may offer, operational procedures, and much more in accordance with their brand standards. And, while owning a franchise does help you to mitigate some of your risk, ultimately you are the driving factor in your success as the business owner. Franchisors want you to succeed and will offer guidance but they aren’t responsible for keeping your business afloat.

You are the primary investor in this enterprise and must obtain the capital it takes to get the franchise rolling. Therefore, you must first decide if franchising is a viable financial option for you. If you don’t already have capital, that often means taking out a loan. The following three-step crash course will help you divide and conquer the seemingly complex world of franchise lending.

Accounting 102: Organizing Your Financial Records

You want to understand and organize your personal and business financial information early in this process. To accomplish this, ask yourself the hard questions:

Which franchise is right for me? While choosing the right franchise based on your professional strengths and interests is an undertaking on its own, your financial health often dictates which franchises are available to you. Here are a few key financial factors to consider as you weigh your options:

• Company background. What is the franchisor’s financial history? How strong is the business currently? How many years has it been in business? How many locations are there? What industry does the franchise serve (dining, education, clothing)? What is the brand presence and recognition, nationally and within your market? Pay close attention to the markets where the brand may not have a strong presence, in some cases, the franchisor is looking to expand in certain areas. Lenders typically consider more established franchises as the sounder investments. Research each company’s background so there aren’t any unwelcome surprises when you head to the bank.
• Initial investment. Some franchises require more capital than others. For example, does the business need a physical location? If so, the initial investment is likely to be much higher than those that don’t. Assess the defining features of the business to quantify your initial investment.
• Compatibility. While this may not seem like a financial factor, choosing a franchise that shares your same core values helps to ensure a strong and steady business relationship. As the franchisee, you are expected to implement, promote, and embody the same business culture as the franchisor. Research and understand the company’s core values and how these values influence the way the business is conducted.

What is my credit score? A strong personal credit score is vital, but there are also other credit scores that should be on your radar. The U.S. Small Business Administration uses the more comprehensive FICO SBSS score to evaluate small business loan applicants. Each lending institution has its own minimum threshold, so get to know your numbers and what doors they may open for you.

What is my net worth? What do you own and what do you owe? Cultivate a list of your assets (cash, checking and savings, stocks and bonds, personal property, retirement accounts, etc.), and liabilities (bills, mortgages, credit card debt, auto loans, college loans, etc.) Then, subtract the liabilities from the assets. That’s your net worth. This collective data becomes your personal balance sheet or financial statement, which is one of the first documents lenders will want to see.

How much money will I need? This question spawns a long list of related questions: What are the franchise fees and royalty payments? What is the difference between capital and reserve? Does the franchisor offer financing or assistance? How long will it take to break even? Don’t be intimidated by the length of the list or the jargon it contains. Work through each question one at a time and utilize the resources available to you to answer them. Scour the web, communicate with potential franchisors, double check your math with financial advisors, and learn from other franchise owners who have already been through this process.

Economics 102: Developing a Business Plan

Lenders use a business plan to determine whether or not you can be a responsible, profitable business owner. After all, they want to know that you have a plan to pay back the loan. Because of this, when writing up your plan, it’s important to make it clear when you think you can pay back the money.

What is in my business plan? You will be sharing this plan with lenders, which means you want be as thorough as possible. In your business plan, be sure to include your pro-forma projections and financial needs, management and personnel structure, marketing strategies, the industry and competitive landscape, and the various parts of the Franchise Disclosure Document (FDD). Be ready to talk about these topics with confidence and specificity.

Lending 201: Which loan is right for you?

A strategic plan for your franchise will likely include acquiring a loan, which means you will encounter lending terminology that may be foreign to you. Here are the fundamentals to set you ahead of the curve.

Conventional Lending. This is a traditional business loan. The specifics of the loan, including interest rates, terms, and payment structures, are varied based on the lending institution.

SBA Loans. A U.S. Small Business Administration loan usually boasts lower interest rates and smaller down payments than conventional loans. An SBA loan helps lenders who invest in small businesses by guaranteeing a percentage of the loan.

SBA 7a Loan: The most attractive characteristic of the SBA 7a loan is its flexibility. With a borrowing range of $50,000 to $5 million, funds from this loan may be used for purchasing the franchise and real estate, construction costs, equipment expenses, hiring, marketing, day-to-day operations, refinancing debt, and more.

Micro-lending. For a smaller enterprise or one-time business need of up to $50,000, microloans may be a suitable avenue to explore. And explore you will – since micro-lending doesn’t require as many hoops to jump through to qualify, it isn’t as common among standard lending institutions and interest rates may be range from low to above average for small business loans.

Graduation: Getting the Green Light from the Lender

We’ve all heard stories about those entrepreneurs who seized the moment and accomplished impossible business feats in a fraction of the time it would usually take to go from dreamer to CEO. But that’s exactly why we hear those stories – they are the exception to the rule. A lending institution wants commitment and vision, but not at the expense of due diligence and professionalism. By scrutinizing your finances, developing a sound business plan, and researching your loan options, you are well on your way to achieving your dream of franchise ownership.

Frank Gallagher is senior vice president, Specialty Financing at United Community Bank. As a national lender in the franchise industry, Frank has more than 28 years of lending experience ranging from franchise start up to large multi-national companies. Frank is considered one of the “best in the SBA market” by his peers and is continually involved within the franchising industry network.