How to Prepare for Franchise Financing Before Making the Leap

Blog April 12, 2024 7 min to read

For many aspiring entrepreneurs, the dream of owning a franchise or starting a business can be exciting and daunting, especially regarding franchise financing. Money is both a barrier and a motivator for starting a business. While some may be able to fund a low-cost franchise through personal savings, others often find themselves seeking external sources for financing a franchise. The good news is that many funding avenues are available for those eager to invest in a franchise.

Before exploring the various franchise loans, grants, and financing opportunities available, let’s first explore the terms, costs, and requirements of initiating your franchise financing journey.

Understanding the Costs of Financing a Franchise

Owning a franchise comes with a mix of one-time and recurring expenses. Buying a franchise business requires an initial investment, of course. If potential buyers don’t have the cash to cover the initial franchise licensing and other startup costs, they must apply for a loan from the franchisor or another lender. After the initial investment, it’s also important to consider ongoing fees. The bulk of these costs and fees must be outlined in the Franchise Disclosure Document (FDD). The FDD provides prospective franchise buyers with the requirements and obligations they can expect from a business relationship with the franchisor. The FDD is not only considered an essential part of the franchise evaluation process. The franchisor must legally provide it to a franchisee candidate at least 14 days before signing an agreement or exchanging any money. Here are some of the common costs and fees you can expect to incur.

Startup Costs: Startup costs can vary greatly from franchise to franchise. Generally, franchise startup costs are the initial investment costs and expenses you’ll incur to launch your new business.
Franchise Fees: Most franchises charge an initial franchise fee, which varies depending on the brand. This fee, payable either upfront or in installments, covers essential startup expenses like training, website setup, and initial supervision. While some franchises offer flexible fee payment schedules, others maintain a fixed structure. If you’re uncertain about fee arrangements, consulting a franchise lawyer can provide clarity. Browse our list of franchises under $100K to get started.
Franchise Royalties: Royalties are ongoing fees, often calculated as a percentage of gross revenue, payable weekly or monthly. However, certain franchises, like TSS Photography, may waive royalty fees altogether.
Advertising & Marketing Fees: In exchange for brand recognition and marketing support, franchisees are typically required to contribute to monthly marketing and advertising fees, usually as a percentage of revenue.

In addition to these standard fees, the FDD will outline a range of other potential expenses, including those related to operational expenses, bank fees, permits, and more.

Creating a Franchise Financing Checklist

Franchise investments span a wide financial spectrum, with opportunities available in various industries and price ranges. While some industries offer affordable entry points, others require substantial capital upfront. Initial research into franchise opportunities provides general investment ranges, while a deeper dive into individual FDDs will offer more precise information tailored to specific brands and industries. However, remember that regional market dynamics must be considered when assessing projected costs and revenues. The FDD can help you fill in the blanks for many of these essential considerations. It provides the data and insights you need to understand your obligations, including the initial and ongoing financial commitments and potential performance metrics.

These are the key franchise financing elements to understand before committing to a franchise investment:

Total estimated startup costs
Financing options for initial expenses
Repayment plans for loans
Revenue generation strategies and key business activities
Timeframe for achieving positive cash flow
Ongoing operational expenses and fees
Contingency plans for unforeseen financial challenges
Long-term business valuation prospects
Anticipated capital requirements over time
Alignment of financial expectations with franchisee experiences
Overall return on investment assessment

How to Finance a Franchise – Actionable Steps

Before you start making moves to build your dream franchise, take these steps to set yourself up for success in the long run.

Create a Budget

First, create a detailed budget to know the total investment required for your franchise. Include franchise fees, operational costs, marketing expenses, and any other upfront costs. Break these down so no expense is missed. A good budget will be your financial roadmap and help you know how much financing you need and where to allocate resources.

Understand Loan Options

Research the different types of loans for franchise financing. SBA loans are popular because of low interest rates and long repayment terms, but they have strict eligibility criteria. Traditional banks, alternative lenders, and even franchise-specific financing programs can also be good options. Compare interest rates, repayment terms, and loan requirements to find the one that fits you. See more about franchise financing options below.

Improve Credit Scores

A good credit score will give you better financing terms. Check your credit report for errors and pay off any outstanding debts. Pay bills on time, reduce credit card balances, and don’t take on new debt. If your credit score needs major work, consider consulting a financial advisor to create a plan and make progress before applying for loans.

Managing Franchise Financing Options

Once you’ve assessed your financial needs and obligations, it’s time to explore franchise financing avenues. Franchisors often assist new franchisees, offering waived fees, loan options, or deferred payment arrangements. Additionally, governmental institutions like the Small Business Administration (SBA) offer loan guarantees, streamlining the financing process for approved franchises. Other financing options include leveraging retirement accounts through programs like Rollovers for Business Start-Ups (ROBS), portfolio loans backed by securities, or unsecured loans from banks, credit unions, or third-party lenders.

Regardless of the franchise financing source, a robust application typically requires documentation verifying credit history, personal financial statements, and a comprehensive business plan outlining investment utilization and revenue projections. Consulting with franchise attorneys and financial advisors specializing in franchise funding can offer invaluable guidance throughout the process.

Finding Your Ideal Franchise Fit

With the financial groundwork laid, it’s time to explore top franchise opportunities aligning with your budget and aspirations. Franchise Business Review provides comprehensive resources and ratings to aid in this search, ensuring prospective franchisees find the best-suited opportunities.

Whether you’re eyeing a low-cost venture or aiming for a high-end investment, careful financial planning and strategic funding choices pave the way for a successful franchise journey.

Frequently Asked Questions about Financing a Franchise

How do I finance a franchise?

There are several ways to finance a franchise, including bank or credit union small business loans, SBA loans, franchisor financing programs, and personal savings. Some franchisees also finance through partnerships or investors to reduce their personal financial burden.

Can I use my retirement savings to finance a franchise?

Yes, through plans like Rollover for Business Startups (ROBS) you can use eligible retirement savings like a 401(k) or IRA to finance a franchise without penalties. But this option has specific rules and should be managed with guidance from a financial advisor or attorney.

How much do I need upfront to start a franchise?

The upfront costs vary by franchise. Franchisees need to have enough funds to cover the franchise fee, initial expenses, inventory, equipment and working capital. These can be a few thousand to several hundred thousand dollars depending on the brand and industry.