When it comes to financing a franchise, you have several options to choose from—withdrawing funds from your retirement account, small business administration loans, financing through the franchisor, home equity loans/second mortgages, borrowing from family or friends, or using your own savings.
If you are opting for any sort of loan or outside financing, there are some steps you can take to increase your chances of success.
Know the basics
When you are deciding how to finance your franchise, you should go over the following list of considerations during your decision-making process:
- Find out what the total cost of financing will be. This includes interest rates, fees to secure financing, first six months operating costs and other factors.
- Determine what personal assets you want to risk as collateral.
- Be clear on the terms and conditions of default for the financing options you are considering.
- Understand how the total and monthly repayment costs work into your current and expected cash flow.
- Know the amortization schedule of the debt, including over what period of time you will have to pay it back and how your monthly payments or interest rates will change over time.
Improving your financing odds
To make yourself into the ideal borrower, you need to focus on the 5 C’s: capital, credit, capacity, character and collateral. This translates to liquid cash for a down payment, a strong credit history, enough cash flow to cover paying back debts, prior experience in the industry your franchise is in and personal property you can use to guarantee your loan. While not having all of these won’t eliminate your chances of obtaining financing, the more boxes you check off for your prospective lender, the more likely you are to raise the necessary capital.
No matter how you decide to finance your franchise, there are five things you can do to increase your odds of being approved for the necessary financing.
- Know the franchise you are interested in. Whether it is the potential location of your new business, or the historical performance of the franchise or the startup and operating costs, any lender will want to have answers to questions such as these. Do your research and be prepared.
- Review the franchisor’s FDD with your lawyer and/or accountant. The Franchise Disclosure Document, or FDD, is a wealth of information and includes important details such as startup and operating costs, current owners with their contact information, marketing support, ongoing support, any existing or previous litigation and other details. The FDD is the most important document you’ll review during your discovery process.
- Create a business plan. Any lender is going to want to see a well-thought-out business plan, including a financial projections section, before they commit to funding. Often, franchisors will provide outlines for business plans to help get you started. The information in the FDD will also help you populate the plan. Always keep in mind the business may not ramp-up as quickly as you like, which means your potential income stream may take longer to development than you initially anticipate.
- Improve your credit rating. Whatever you can do to boost your credit score should be done. That could mean holding off on buying a new car, paying down some of your debt or even simply paying all your bills on time. A good credit rating is one of several factors that will go into deciding your interest rate, payment terms and maximum loan amount.
- Have your collateral money ready. Lenders want to know that you have some skin in the game. Most will require a 10 to 20 percent down payment to show that you have a vested interest in the financial success of your future franchise. Of course, if you can put down more than the required amount, all the better.