A man wearing an apron stands in front of a coffee shop counter, behind which is mounted a menu.
Franchise financing, like franchises themselves, can come in various forms with different benefits. — Getty Images/aydinmutlu

When you buy a franchise, you are buying a tried-and-true entity. Your small business will likely have the same products, procedures, logos and ambiance as those of other entrepreneurs. Your financial situation, however, is unique to you, and may be quite different from that of people running very similar businesses.

Finding the right financing, just like finding the right franchise opportunity, will require both the assistance of an accounting professional and your personal due diligence.

[Read more: 4 Experts Share Their Business Funding Strategies]

Lenders will want to see a detailed business plan. Being a franchise can be a plus here, as the plan you present will be a proven one. Of course, prospective lenders are also looking at you. Your credit history, business and tax records will all play a role in what options are ultimately available.

Any entrepreneur looking for launch funds will need a solid understanding of all the costs involved. Anticipating the cash needs of a business for the first few years can be difficult — another advantage of purchasing a franchise. For better or worse, the franchisor will dictate a fair amount of what a franchise spends its money on, and this information is available to you in the Franchise Disclosure Document (FDD). This document — required to be supplied to prospective franchisees—spells out any and all financial obligations between the contract parties. By adding the initial purchase price, the costs of equipment, inventory, advertising, training and anything else spelled out in the FDD, you can begin to home in on your cash requirements.

The FDD also contains contact information for all past and current franchisees. These businesses can provide information on their individual experiences, not the least of which will be how accurate the parent company’s projections are. Question those who have gone before.

When you have determined the actual amount of financing you need, you are ready to review your options.

While not banks, alternative lenders do loan money — sometimes to those banks have turned down, sometimes to those in a hurry.

The franchisor

According to Jared Hecht, co-founder and CEO of Fundera, if your franchisor offers financing, your search for funds might well start and end with them. They know their business better than anyone, Hecht reasons, and may offer the inside track for the purchase of equipment and other necessities for getting your business off the ground.

While the Wall Street Journal agrees that franchisor financing is a viable option, it points out that the possible trade-off for not putting up collateral may be higher interest rates.

Commercial bank

Commercial banks and credit unions are traditional places to find start up financing. If you have a working relationship with a bank, good personal and business credit ratings and time to do the required paperwork, they are an excellent option.

Keep in mind, banks don’t want to own all of the risk. They will generally require collateral—equity in your home, for example—and a significant (20% at a minimum) contribution from you. Banks are conservative by nature. Franchise funding will be easier to obtain if the franchisor is a well-known one, with a successful track record.

SBA loan

If the franchise you are purchasing is on the list of those approved by the Small Business Administration, consider applying for an SBA guaranteed loan.

According to Entrepreneur, these loans can come with lower interest and bigger borrowing amounts, making them a highly advantageous form of franchise financing.

Alternative lenders

While not banks, alternative lenders do loan money — sometimes to those banks have turned down, sometimes to those in a hurry. The quicker turnaround time and less stringent requirements offered by these lenders come with a price. Interest rates may be higher and repayment times shorter.

The good news for prospective franchisees is the existence of online lenders—Boefly and ApplePie Capital, for example—specializing in franchise financing. Some have established relationships with specific franchisors, who find it in their best interest for aspiring franchisees to have access to startup funds.

Borrow from yourself (ROBS)

According to Guidant Financial, ROBS (Rollovers for Business Startups) is a complex mechanism for turning your 401(k) savings into seed money. Despite the many steps and tight regulations, an entrepreneur in need of $50,000 or more to purchase a franchise may find a ROBS well worth the cost and effort.

Advantages of a ROBS include speed, the lack of a credit check or interest charge and the ability to access funds without putting your home or other assets at risk.

[Read more: How to Use your 401(k) to Fund Your New Business]

Additional options

Other avenues for funding a franchise purchase include borrowing from friends and family, attracting an angel investor and crowdfunding—all of which may be made easier if the franchise is a known entity. Finally, tapping the equity in your home through a Home Equity Line of Credit (HELOC) or borrowing against your investment portfolio are also possibilities. The viability of these options will vary, depending how much money you need, how much time you have and how much risk you are willing to take.

Obtaining franchise financing might be a lot of work, but with the right business chosen and funding in place, the obvious next step is entrepreneurial success.

CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.

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Published October 23, 2020