People ask me how to pay for a franchise before they even know what the whole investment looks like. Flip that. First, get clear on the high end of Item 7 and the cash you’ll need while the business ramps up. I cover that in How Much Does It Really Cost to Buy a Franchise?. Then look at funding.
Here are the options I see most often, explained without the brochure language.
Personal Savings and Other Cash You Already Have
The SBA calls this self-funding or bootstrapping: using your own savings, or capital from friends and family. You keep control. You also take all the risk. Don’t empty every account. Leave yourself a personal cushion.
If you’re thinking about tapping a 401(k) or other retirement money, slow down. The SBA specifically says to check with your plan administrator and a personal financial advisor first, because early withdrawals can carry fees, penalties and long-term damage to your retirement. I cover the ROBS structure separately in Can I Use My 401(k) to Buy a Franchise?.
SBA 7(a) Loans
The 7(a) program is the SBA’s primary business loan guarantee. You don’t borrow from the SBA. You apply through a participating lender. The SBA guarantees part of the loan so the lender is more willing to say yes.
According to the SBA, 7(a) loans can be used for:
- Real estate and buildings
- Working capital
- Machinery, equipment, furniture and supplies
- Changes of ownership
- Multiple purposes that combine the above
The maximum loan amount is $5 million. To be eligible, the business must operate for profit in the U.S., meet SBA size rules, be creditworthy, show a reasonable ability to repay, and not be able to get the credit you want on reasonable terms from non-government sources.
Most 7(a) term loans are repaid with monthly principal and interest from the business’s cash flow. Your lender decides the package you’ll need. The SBA’s Lender Match tool can help you find a participating lender.
Check the SBA Franchise Directory
If you’re hoping for SBA financing, look up the brand in the SBA Franchise Directory. For brands that meet the FTC definition of a franchise, the brand generally has to be in the Directory to get SBA financing. Placement is not an endorsement or approval of the brand, and it does not ensure success. The SBA is clear about that.
When a franchisee applies for SBA-assisted financing, the franchisor and franchisee must use SBA Form 2462, the Addendum to Franchise Agreement.
Financing From the Franchisor
Some franchisors offer financing themselves, or help you find it. Look in Item 10 of the FDD. If they offer financing, the terms have to be disclosed. Compare those terms to a bank or SBA loan. Easier is not always cheaper.
Friends, Family and Partners
This route is common, and it can get messy. Put the deal in writing: who owns what, who’s on the hook for the loan, and what happens if someone wants out. Have an attorney draft it.
What Lenders Want to See
Before you chase any loan, get your house in order:
- A clear business plan and financial projections
- A solid personal credit history
- Enough of your own cash in the deal
- Answers ready about the brand, including Item 19 and Item 20
Lenders look past the brand name. They want to know you can repay the debt if sales come in slower than you hope.
Don’t Overborrow
The biggest funding mistake I see is borrowing as much as someone will lend. Borrow what the business can support after royalties, rent, labor and your own living expenses. If the only way the deal works is perfect sales from day one, it doesn’t work.
Want Help Matching the Money to the Brand?
If you’re looking at a franchise and want to talk through how to fund it, I’m glad to walk it through with you. No pressure. Call me, John Henning, at 267-417-4980.
Sources
- U.S. Small Business Administration, 7(a) loans: https://www.sba.gov/loans/7a-loans/
- U.S. Small Business Administration, Buy an existing business or franchise (self-funding, Franchise Directory): https://www.sba.gov/business-guide/plan-your-business/buy-existing-business-or-franchise
- SBA Franchise Directory: https://www.sba.gov/document/support-sba-franchise-directory
- SBA Form 2462, Addendum to Franchise Agreement: https://www.sba.gov/document/sba-form-2462-addendum-franchise-agreement