Starting or buying a franchise offers the opportunity to achieve the entrepreneurship dream while capitalizing on the structure of a franchise system. As this dream takes shape, it's important to determine how a small business owner (SBO) can finance their franchise, since many variables affect their ability to secure credit. It's important for entrepreneurs to understand the available financing options and be aware of how "fine print" such as fees, collateral, loan terms and more can impact the total cost of credit. When seeking a loan or line of credit, savvy franchise owners will weigh the pros and cons of finance options including U.S. Small Business Administration (SBA) loans, conventional loans, Rollovers for Business Startups and inclusion of equity investors. With these options, which type of financing may be the best fit for achieving business success as a new franchise owner?
One option SBOs may consider are SBA 7(a) and 504 loan products, since these loans can provide cash savings, lower down payments and longer terms than conventional loans. The SBA guarantees a portion of these loans for banks, meaning that these lenders are usually more willing to approve these loans for SBOs who may not have the credit score or history needed for a conventional loan.
SBA 7(a) loans help business owners obtain financing for general business purposes, including working capital; buying equipment or furniture; buying or renovating buildings and refinancing debt. 7(a) loans of up to $5 million are issued with terms of up to 10 years for working capital and 25 years for fixed assets, compared to conventional loans that typically carry 15- to 20-year terms. Lower equity injection requirements, typically 10 percent, and a longer term (or payback period) create lower monthly payments, allowing SBOs to preserve their cash so they can invest excess funds into their businesses. However, 7(a) loans are typically more expensive upfront, always require a personal guarantee and if not fully secured, SBOs must provide a lien on other personal assets, including their home.
Like 7(a) loans, SBA 504 loans require less money down and have longer terms, but can only be used as long-term, fixed-rate financing for purchasing major assets like real estate and long-term machinery or to renovate facilities. This means that any startup cost (including franchise fees) would come out of the franchisee's pocket or be covered through...