Q: What are the best practices for financing a franchise?
A: The Franchise Disclosure Document (FDD), which the franchiser is required to provide potential franchisees, will have a specific section titled “Estimated Initial Investment.” This section outlines a range, depending on the site and other factors, to open a business under your franchise agreement. Keep in mind that you will also have some unknowns and a learning curve, so add 20 to 30% to the number in the investment section to give yourself a cushion and a realistic financial target.
Once you know the total amount, the decision is how much available cash (equity) you can contribute to the business. A good guideline is 30% of the necessary investment.
This leaves a 70% gap to be filled with bank financing or some other source. Your franchiser may have a list of lenders it has prequalified who are predisposed to lend to its franchise community, so start with the franchiser’s approved lender list.
Your next source is national lenders that specialize in franchise lending. These lenders typically are large banks that have franchise lending departments, such as Wells Fargo, Bank of America and Bank of Montreal (BMO).
Your best option may be your local bank, where you already have a personal relationship, however. Your bank will review your business plan to understand your franchise concept and how you plan to operate it. In many cases, the local banks will work through a process to qualify your loan as a Small Business Administration (SBA) loan. The SBA has a deep knowledge of franchise concepts and provides your bank with an SBA guaranty.
Besides financing, there are two other important considerations: 1) make sure you are operating your franchise business in a separate legal entity for personal liability protection, and 2) while you usually can’t avoid personal guaranties to your lender (particularly SBA loans), try to limit the guaranties by having them burn off as your franchise business matures.
Fortunately for new franchisees the franchise business model is well understood by the lending community. The same due diligence you put into finding your concept needs to be spent finding the ideal lending partner. Franchising, after all, is a business of relationships.
Dennis Monroe is a senior distinguished fellow at the University of St. Thomas School of Law, and co-founder and chairman of Monroe Moxness Berg PA. This is part two of a four-part series on franchising.