Consultant Mary Pang of FranFund shares financing options and strategies for helping franchisee candidates fund their businesses – and change their lives.
Today more than ever before, helping franchisee candidates secure funding to buy a franchise is an integral part of doing business in the industry – and it can change lives in the process.
When it comes to selling franchises, making sure franchisees understand the funding options available to them is critical for getting started on the right path. From SBA loans to alternative options like rollover programs and credit lines, helping candidates make smart financial decisions early on can mean the difference between opening a successful new franchise location or missing out on a great opportunity to scale your brand.
In this article, we’ll explore what every franchisor needs to know to help their franchisee candidates secure the right funding to meet their needs – and bring their dreams to life.
Takeaways:
- Knowing where to look to secure funding and loans is an integral part of buying a franchise.
- Despite recent economic uncertainty, Small Business Administration (SBA) loans are still being made available to many borrowers.
- By taking time to understand funding options and keeping an eye on the current lending climate, emerging franchisors can ensure their franchise systems are properly funded and financially secure.
Today’s lending situation
It’s no secret that interest rates have fluctuated over the last year, leaving entrepreneurs, investors and others in uncertain territory as they navigate the world of economics and business. But how much of an impact has that economic uncertainty had on franchising?
According to Mary Pang, senior funding consultant at FranFund, an organization that specializes in connecting franchise industry professionals with custom all-in-one funding plans, lenders are still lending – and franchisors are still changing the lives of their franchisees by helping to connect them with the right resources to fund their business goals.
“One of the biggest questions I get is, are people still going to fund [their franchise] with SBA (Small Business Administration)? Absolutely – you know, borrowers are still borrowing; lenders are still lending. The requirements that SBA lenders were looking for a year ago, two years ago, three years ago – they're still looking at the same requirements,” Pang says.
Despite increasing interest rates, Pang says franchisees are still adamantly pursuing their business goals.
“Interest rates are not stopping the folks that we're talking to from getting into business,” Pang says, adding that interest rates can change over time or mean different things to different people depending on their mindset, goals and financial situation.
“Maybe looking at interest rates [increasing] can mean one thing to one person. And to another, they see it as an opportunity,” Pang says.
Small business loans are a common source of funding
Regardless of a candidate’s perspective on interest rates, once a decision has been made to buy a franchise, the most important next step is identifying the right sources of funding for their individual needs and goals. For many franchisees, one the most common sources of funding is obtaining a small business loan through the SBA.
“This is going to be a program where people are leveraging debt financing. There's going to be four different qualifications that lenders are going to want to see a borrower be able to check off those different boxes in order to obtain that level,” Pang explains.
To qualify for an SBA small business loan, Pang says applicants usually need a credit score of 680 or higher with a clean, strong credit history and no foreclosures, bankruptcies or short sales within the last five to seven years. Loan officers also look for liquidity requirements to satisfy the required 20% cash injection into the total initial investment cost of the new business.
“After that 20% cash injection goes in, the bank is never going to loan them the full amount of what they need to get into the business. But it's going to be able to help them leverage what they have to maybe invest into a larger investment,” Pang explains.
Finally, loan applicants will typically be evaluated for personal assets and collateral. Because of that, Pang says it’s important for franchisee candidates to make sure they have additional cash resources available to cover operating expenses, personal expenses and a lease payment during the initial period when the new franchise business might not be profitable – a point that could be a dealbreaker for some franchisee candidates.
“The other side of that, maybe a con for some people, is that there are also a lot of times lenders will ask clients to use the personal assets as collateral for that loan. And so maybe that's someone's real estate, maybe that's an investment property that they have, maybe that's an investment portfolio. … It's not a set-in-stone requirement, but it is something to be aware of,” Pang cautions.
Alternative funding options for franchisee candidates
Although Pang says small business loans make up about half of the funding sources clients typically apply for at FranFund, there are plenty of other funding options available to franchisee candidates that they might not be aware of if they’re just getting started in the franchising world.
“As much as [candidates are] doing their due diligence on the actual franchise brands that they're exploring – making sure that it's a good brand that's going to help them change their future and their family's futures – the same thing should be happening on the funding side,” Pang says.
To make sure franchisees are aware of the funding options available to them, making sure educational resources related to loans and funding are available to franchisees during the franchise sales process can be helpful.
Rollover for Business Startup (ROBS) Program
For franchisee candidates looking for alternatives – or add-ons – to SBA loans, the Rollover for Business Startup (ROBS) program, sometimes referred to as the ROB Strategy or the 401(k) Rollover, is a common source of funding.
“[ROBS is] an IRS-regulated program that allows someone to invest their eligible retirement funds into their own business without any income taxes or early withdrawal penalties. And they're also able to use the full value of these funds. ... This is a strategy where it's not a loan, so you're not going into debt – you're not borrowing money. There's nothing to pay back,” Pang explains.
The decision to utilize ROBS should be made thoughtfully and with careful research based on each franchisee candidate’s financial situation and comfort levels. While some franchisee candidates might be uncomfortable with the idea of dipping into their retirement accounts to open a franchise, others could see it as an opportunity to invest in their future, depending on their circumstances and retirement goals.
“If someone is looking at the market and they're saying, ‘I'm not really loving what [my retirement funds are] doing in the market right now, I think I can do better.’ [ROBS can be] a great way to actually diversify someone's investment portfolio, where the vehicle is their business and they're literally investing in themselves,” Pang says.
Although ROBS is sometimes used as a standalone product program for new franchisees, Pang says it can also be used in combination with an SBA loan or other funding source to help cover the equity injection or liquidity requirements.
Securities-back credit lines
“Another common strategy we'll see is, let's say someone has an investment portfolio – maybe they've got some investments sitting in Vanguard or Fidelity or Charles Schwab. They can actually leverage what's called a securities-backed line of credit,” Pang says.
With a securities-backed line of credit, franchisee candidates have the option of leveraging funds in the same way they might leverage the equity in their home – without having to withdraw the funds to invest in a business.
Like ROBS, leveraging investment funds is a strategy that can be used on its own or in combination with other funding sources such as small business loans, depending on the needs of the candidate.
Home equity credit lines
For franchisee candidates that own their own homes or have significant equity invested in their homes, a home equity line of credit can be an option for funding a franchised business.
“They could leverage that home equity line of credit through their local bank to either get something up and running, or they can also use that in combination with, let's say, the SBA program,” Pang says, noting that banks will typically still want to see cash resources to help cover an equity injection before approving a home equity credit line.
Unsecured term loans
For candidates that are hesitant to use their primary residence as collateral when funding their franchise investment, Pang says unsecured term loans can be a smart option.
“This program is one where there's no collateral requirement, and there's no requirement on what someone uses those funds for once they have access to them,” Pang explains.
Although interest rates can fluctuate depending on the borrower, Pang says she’s seen clients borrow anywhere from $30,000 to $650,000 – making it an option for borrowers of all levels.
“Everyone's financial situation is different, everyone's specific goals and needs are different – where they're coming from is different. And so it's really important to actually be able to take a full overview of someone's financial snapshot and then build a funding strategy that's going to make the most sense for them. And maybe it’s a combination of different strategies,” Pang says.
Customizing funding to the franchisee candidate
When it comes to helping franchisees find the right funding for their business goals, it all comes down to making sure their funding plan is tailored to their specific needs.
“Really, I think the most important thing is having an understanding of how you can leverage your financial picture in a way that's going to benefit you in the future,” Pang says, adding that looking at each applicant’s individual financial picture from a high level can help consultants draw up a funding plan that will address their needs and help them meet their goals as business owners.
At FranFund, pre-approval letters are often a useful tool for helping clients get an idea of whether or not they might be approved for a specific type of funding, like an SBA small business loan – something that can be helpful for franchisors during the franchise sales process.
“[FranFund has] a 99% success rate for the folks that we've provided the approval letter for. Now, that doesn't mean that we're issuing a pre-approval letter to 99% of the folks that we're talking with. But if you've been given that letter, both on the franchisor side and the candidate side, that's a pretty good indicator that you should move forward with this,” Pang says.
Best practices for emerging franchisors
Although the franchisee loan application process tends to center around the prospective franchisee, new and emerging franchisors should be aware that the SBA also evaluates startup franchisors – even if they don’t have a track record of business activity yet. Because of that, emerging franchisors can benefit from taking certain steps to make their franchise system more attractive to lenders early on.
1. Get listed in the SBA Franchise Directory
“As an emerging franchisor, get on the SBA (Franchise) Directory. We work with a large network of lenders nationwide. These are lenders that aren't afraid of running loans for startups. They don't require that the borrower necessarily comes to the table with industry experience, which on a local level is often a requirement. And they're also going to be educated on the different franchise brands that we work with. But every single one of them is going to look at that SBA Directory first to see if that franchisor is approved by the SBA,” Pang advises.
Since getting listed in the directory is typically a three- to four-week process (though it can sometimes take longer), it’s important to start the process as early as possible. And while being listed in the SBA Directory is a good start for new franchisors, it probably won’t be enough to convince some lenders. Because of that, new and emerging franchisors should also focus heavily on over-supporting their first few franchisees.
2. Over-support early franchisees
Because lending for startup franchises is often determined by the brand’s track record of success, franchisors can benefit from making sure their first few franchisees are fully supported and prepared for success.
The performance of the first few franchisees will establish a reputation for the emerging brand in the lending community. This reputation can go two ways: 1) having 20 high-performing franchisees that validate well; or 2) having franchisees within that 20 that default on their SBA loan. Lenders view a loan default as both the candidate/borrower's and the emerging franchisor's responsibility.
3. Don’t wait to qualify candidates
Emerging franchisors can also benefit from making sure they’re qualifying prospective franchisees for funding early in the franchise sales process. In addition to weeding out candidates that aren’t serious about becoming franchisees, this strategy can also help ensure that even the most serious candidates are well-qualified and a good fit for the franchise system.
“Don't wait until your candidate has gone to discovery day and you've fallen in love with them and they're in love with you before you figure out if they can obtain funding or move forward with the franchise. You're going to want them to have some kind of a funding strategy in place before they're going to meet the CEO and meet the team, etc.,” Pang says, adding that the subject can easily be brought up after a candidate has reviewed the Franchise Disclosure Document (FDD).
Smart funding can have a lasting impact
Although there are immediate benefits for franchisees obtaining funding for their businesses, including opening new locations with enough cash on hand to support business operations, making sure a franchisee is properly funded can also have a life-changing impact that extends beyond a franchisee’s first few years in business.
“Setting interest rates aside, if you're making a good decision as a franchisee candidate, a franchise buyer, if you're buying into the right franchise system – and that's a big if – you're really looking to transform your financial future. And that goes beyond whether interest rates are X or Y,” says Charles N. Internicola, a franchise attorney with over 25 years of experience and the founder of The Internicola Law Firm.
Often, that transformation happens when franchisees learn how to use SBA loans in combination with other types of funding – establishing a strong financial foundation for sustainable growth over time.
“I think smart franchisees know how to use SBA loans,” Internicola says, explaining that by combining funding strategies in smart ways, franchisees can achieve success and increase their business opportunities while making an impact on the lives of family and friends around them for years to come – particularly for franchisees with a multi-unit mindset.
Although purchasing multiple locations can be tricky, it isn’t impossible to obtain funding. According to Pang, criteria can differ between brick-and-mortar locations and service-based or mobile franchise locations; however, lenders funding brick-and-mortar businesses tend to look for specific criteria before investing in a second or third location.
“A common funding strategy that we'll see [multi-unit] folks use is they'll use SBA [loans] for that first location because that's going to be the easiest SBA loan to attain. And the reason for that is for locations two and three, in those subsequent locations, lenders are also going to want to see either 12 months of performance history or six months of positive cash flow, whatever comes first,” Pang says, noting that other criteria are also taken into account when financing multiple locations.
Despite the challenges, opening multiple locations can pay off for franchisees in terms of long-term financial stability – including later down the road when younger family members might join the family franchise or manage one or more locations.
“When I look at certain multi-unit operators, and when I reflect even on personal friends that have multi-unit operations, SBA loans have helped them create generational wealth,” Internicola says.
For Internicola, that long-term success comes down to more than just money. It’s about franchisees finding the right franchise system to grow in – and the right franchisor to learn from and flourish under.
“Good franchisors care about the franchisees. … I always think about the franchisees that maybe only gave that first location a shot and it doesn't work out and you realize the goals and the values – just sticking with a process, which assumes you're working with the right franchisor,” Internicola says.
To learn more about the funding plans and services offered by FranFund, visit https://www.franfund.com.
