If you’re starting a franchise business, you may need financing to pay your franchise fees, lease your location, handle construction, purchase equipment, or buy inventory.
In my experience, other than cash, most people use SBA loans, HELOCs, and ROBS. However, there are a couple options that can beat all three!
In this guide, I’ll present 9 types of franchise financing in a general preferential order.
To be clear, the order I suggest is just a guide. The loan that works best for you will depend on your specific circumstances.
For each option, I’ll walk you through the pros and cons, my tips and suggestions, and your next steps to finance your franchise.
Let’s get started!
If you have plenty of cash on hand to cover your franchise startup costs, then cash could be your best financing option, or at least a big part of your financing mix.
The primary advantage of cash is that you can minimize risk exposure. You won’t need to break into your retirement account or take out a second mortgage on your house.
You won’t need to pay for a costly loan. You won’t need to worry about interest rates, payment terms, or making payments. And you’ll have complete control and ownership over your business.
What’s not to love?
To use cash, you need to ensure that you can more than cover the costs of starting your franchise. You have to meet all of your franchise requirements. In addition, you should set aside extra cash so you can comfortably operate.
If you can’t cover 120% of your startup costs, then I would line up additional financing just so you have it on hand. If you have a strong financial background and a solid credit history, you should be able to get the very best interest rates.
Franchises love to sell you extra territory, and it’s usually a great deal for you – one you may look back on with regret if you miss out on.
Usually franchises will offer you extra territories at a discount when you sign up. To sweeten the deal, they sometimes offer reduced royalties or lower franchise fees.
These perks will almost definitely not be available after you sign. And the extra territory itself may also get bought up by other franchisees.
So, if you can, it pays to invest early. Extra financing can be critical so that you can comfortably make the extra investment in territory. This will allow you to set yourself up for bigger returns as you grow multiple locations instead of just one.
Of course, there are opportunity costs to using all cash. Some franchise candidates like to mix cash with other financing in order to:
The franchise you buy from may offer internal franchise loans, also known as in-house financing. Most franchises will clarify whether they offer financing in their Franchise Disclosure Document (FDD).
Internal loans are one of my favorite sources of franchise financing. It’s in a franchise’s best interests for franchisees to be successful, so their loans are designed to assist capable franchisees.
Typically, a franchise's objective is to help you start your business and become profitable as soon as possible.
With an internal franchise loan, you can usually get money faster and with less documentation than from outside lenders. Franchises know their business, so they aren’t going to require you to provide superfluous details in your business plan. Instead, they’re more interested in your analysis of the territory where you propose launching your franchise. This more streamlined process can save you a lot of hassle and stress.
There are possible downsides to internal franchise loans.
Potentially, internal loans can lower your interest rates and give you flexibility without any meaningful downsides. Still, it’s a good idea to explore more than one option, so I always recommend getting at least one other loan offer outside of a franchise’s in-house financing.
Even if you don’t think you need financing, I suggest speaking to any franchise you’re interested in about what kind of franchising loans they offer. This just gives you flexibility so that you can make the best decisions for your personal and business finances.
A home equity line of credit (HELOC), commonly called a “second mortgage”, is a loan that lets you use the equity in your home as collateral.
With a HELOC, you’ll receive a revolving line of credit that you can use to start your business. The interest rate on a HELOC is often lower than other types of loans, and the interest may also be tax-deductible.
The interest rate on a HELOC may be variable, so it could change each month based on a financial index and a constant margin. However, some lenders will offer you the option to convert a portion of the balance to a fixed rate.
A HELOC is ideal for entrepreneurs who own a home and have available equity in it. That is to say, the amount you owe on your home must be less than the value of your home.
You can typically borrow up to 85% of the value of your home minus the amount you owe.
You’ll also need a good credit score, credit history, employment history, and a steady income. Your lender will also consider your monthly debts.
Using a HELOC as a financing option for your franchise business comes with several benefits.
It's important to consider the following drawbacks before deciding to use a HELOC.
Because your house is at stake, it's important to make sure you can repay a HELOC loan before you take out a HELOC. You can consult with your accountant to get their advice on the smartest way to finance your business.
If you’d like to check out interest rates before speaking to your accountant, you can explore today’s HELOC rates at Bankrate.com.
Many of my candidates use ROBS (rollovers as business start-ups). This allows them to fund their franchise businesses using their retirement savings.
With ROBS, you simply take the money you’ve saved in a retirement account, like a 401(k) or IRA, and invest it into your business.
ROBS is an ideal funding source if you have a substantial amount of money saved in a retirement account and you’re willing to invest that money into your new business.
The most significant advantage of using ROBS as a funding source is that it’s not a loan or a withdrawal! This means there are no payments, penalties, or interest.
To use ROBS, you must meet the following conditions:
ROBS provides several advantages to new franchisees.
Of course, the benefits of ROBS will depend on your individual circumstances and the laws of your state. A ROBS specialist or financial advisor can provide more insights to help you determine if ROBS is suitable for you.
ROBs carries several disadvantages, notably:
Obviously, the final drawback here is quite significant. To protect yourself, I recommend that you only use ROBS if you are confident that you have at least one income fallback in the event your business doesn’t work out. Perhaps you have an investment house, an additional family income, or you don’t mind working again for some additional years.
If you have a substantial retirement account, you can leave most of it alone. Then you can limit your risk to just a portion of the account that you can afford to lose.
(I know an excellent ROBS specialist. So, if you’re looking for advice, please email me and I’ll be happy to put you in touch.)
There are several laws and regulations that govern the use of ROBS, including the Employee Retirement Income Security Act (ERISA). To avoid tax penalties, you’ll want to work with an accountant experienced with ROBS to get everything set up perfectly.
The IRS states that it does not consider ROBS to be “abusive tax avoidance transactions”. However, the IRS has observed that “promoters aggressively market ROBS arrangements to prospective business owners.”
Some companies apply for a favorable determination letter (DL) from the IRS to assure their clients that the ROBS arrangement is approved. However, a DL only confirms that the plan meets Internal Revenue Code requirements. It does not protect against incorrect application of the plan's terms or discriminatory operations.
It’s important to understand that if your ROBS arrangement only benefits you and not other employees of your business, the IRS may consider it discriminatory.
If you use ROBS, speak with a trusted ROBS specialist and make sure that you are able to follow all the rules and requirements of the plan. If you don't, the IRS could disqualify the plan and hit you with additional taxes.
If you’d like to read more yourself before meeting with your accountant, I suggest reviewing Guidant’s guide to ROBS.
None of this is meant to scare you. I’m a fan of ROBS. I just want to make sure you’re aware of these nuances that need to be set up properly.
Small Business Administration (SBA) loans are popular for franchise funding. These loans offer lower interest rates and more favorable repayment conditions than traditional bank loans.
In a 2022 Franchise Ventures survey, nearly half of small businesses reported that they planned to take out an SBA loan.
SBA loans are partially funded by the Small Business Administration (SBA), a U.S. government agency that helps small businesses succeed. Since lenders are guaranteed to get their money back thanks to the federal government, SBA loan providers have more incentive to offer relaxed repayment schedules.
The Small Business Administration is very supportive of franchise investments. Still, qualification criteria can be stringent. To be eligible for an SBA loan, you must:
SBA loans often require a lengthy application process. You’ll want to gather financial statements, tax returns, business plans, and other documents that demonstrate the viability of your business.
To apply for an SBA loan, you'll need to work with a lender that has been vetted by the SBA. This process can involve several steps and may take around 30 days to complete.
The SBA offers multiple types of small business loans, including the SBA 7(a) loan, the SBA Express loan, and the SBA 504 loan.
The SBA 7(a) loan is the most popular product offered by the SBA. It allows businesses to borrow up to $5 million for a variety of purposes. The approval process can take 2-3 months depending on the lender and the borrower.
The SBA Express loan is a faster option for businesses that need emergency funding. This loan allows businesses to borrow up to $350,000, and the SBA promises a turnaround time of 36 hours. However, the actual approval process can take longer than this for the lender to review your loan application and make a decision.
The SBA 504 loan is a long-term loan specifically designed to help you purchase fixed assets like real estate or equipment. Businesses typically use this loan to expand or modernize their operations. The approval process for an SBA 504 loan can take several months since it involves multiple parties, including the SBA, the lender, and a certified development company.
The two most popular SBA loans are the SBA 7(a) loan and the SBA 504 loan.
I recommend checking out Fast Capital 360’s side-by-side comparison of these loans.
To help you further, I have several SBA financing partners who specialize in financing franchises who I can introduce you to. I trust them to give you the best customized option based on your situation, with no obligation. If you would like to talk with them, just say the word.
Banks tend to work best for companies that have been around for more than a year and don’t need cash fast. So, they’re usually not ideal for new franchisees.
Traditional bank loans are a good option for franchisees with a strong credit history and financial profile, as well as collateral to secure the loan.
Traditional banks often offer competitive interest rates, long repayment terms, and a wide range of loan products. If you have a strong credit score, you may be able to negotiate favorable loan terms.
Approvals can take months and are not guaranteed, even with good credit. According to the latest data from the Biz2Credit Small Business Lending Index, banks only approve 15% of business loan applications.
The bank loan application process requires time-consuming documentation. You’ll usually also need to provide collateral, such as a mortgage on your home.
Many people avoid bank loans due to perceived high interest rates. Keep in mind, interest rates vary depending on the bank you choose. To give yourself options, get quotes from at least one credit union and one commercial bank.
Each bank will ask to review your credit history and your business plan to make sure you can comfortably manage repayments. Once you qualify for a bank loan, you will receive the stipulated amount upfront. You’ll then be expected to pay monthly installments with interest until you pay off your loan.
Bank of America, JP Morgan Chase, Citibank, and Wells Fargo each offer small business loans. Here’s a brief comparison table.
Alternative lenders can be a lifeline if you’re eager to start your franchise but you can’t secure an SBA or bank loan. Many offer short-term loans, business lines of credit, and long-term loans.
Alternative lenders have more lenient requirements. They typically require a one-page summary of your business instead of a detailed business plan. They also offer faster turnaround and shorter repayment periods.
The tradeoff is that they’ll charge you higher interest rates. Additionally, alternative lenders are usually smaller than banks, so the amounts they offer are typically smaller.
I’ve prepared a roundup of business loans geared towards small businesses.
I have not taken out loans from any of these organizations, so I cannot speak from personal experience. However, I hope this summary is helpful as a starting point in your research if you’re looking into alternative business loans.
You can supplement your personal financing with a small business credit card.
Be extremely careful with this option. Use it sparingly, if at all. The point of franchising is to create more financial security, not less.
Of course, cards are great for earning points. Additionally, many cards offer a certain amount of time with 0 interest.
High interest rates kick in immediately after this period ends. It’s important to focus on earning revenue in the short-term so you can pay off your card before interest starts accumulating.
A credit card lets you:
However, there are risks:
Carefully consider the benefits and risks before using credit cards for startup funding. Then take measures to protect your business.
If your personal savings are not enough, you can consider asking for assistance from your friends and family.
You’ll want to gauge whether this is appropriate based on your family relationships and your family’s level of financial security.
ZenBusiness offers some suggestions for pitching to your friends and family professionally.
Loans can strain relationships. To avoid this, I recommend explicitly telling your friend or family member that you will do everything you can to repay your loan on time.
Promise to limit or cut off your discretionary spending until your loan is paid off, and discuss what that will look like. This will give you the mental framework to pay back your loan promptly. It will also show your friend or family member how seriously you take your responsibility to pay them back.
Setting the right expectations will help you avoid surprises down the road.
I suggest only using funding from friends or family as a booster for your business.
For example, you could use funds from friends for a quick cash infusion while you wait for your SBA or bank loan to be reviewed. Then you can repay your friend once your loan is disbursed.
Just be careful to avoid promising your friend that your SBA or bank loan will be approved, since you cannot know this for certain.
If you don’t have cash to fully fund your business, you’re not alone. The good news is that most institutions will not lend to you unless they are quite confident that you can repay your loans.
In review:
If you’re eager to experience financial freedom, I would love to meet with you!
Get in touch with me today to set up a free meeting.
I can help you choose the right franchise for you – and the most viable funding source – so you can build the business of your dreams.