The Ins-and-Outs of Franchise Financing

Posted on May 25, 2011 by Bryan Nisperos

Financing a franchise can be a difficult prospect, particularly if your aspiration is to open a large-scale franchise operation such as a restaurant or hardware store. The amount needed for a franchise varies greatly (from as little as $1,000 to millions at the high end), but a typical restaurant franchise, for example, will land somewhere between $50-$500k. While you may have the capital to get started on your own, self-funding a business of any kind is a risk that most people aren't willing to take, so let's take a look at three popular ways to finance a franchise.

Small Business Loans
The most traditional way to start any small business is with a small business loan. Banks will typically look favorably upon franchisees, since they're starting a business with a proven business model. Like any loan, you'll be required to pay it back with interest, but unlike raising money from investors, you won't be giving away a piece of the company to the bank in exchange for the loan. A small business loan is a great choice for a franchisee that has excellent credit, wants to retain 100% ownership in the company and has enough business experience to balance cash flow and keep the payments going to the bank each month.

Franchisor Programs
One of the unique aspects of starting a franchise, vs. starting a small business from scratch, is that you have a parent organization that’s in your corner, and the success of your business is in their best interest. This is not only helpful in terms of the perks you'll receive (national marketing and ad campaigns, supply lines, etc.) but many franchisors also offer creative financing options in order to encourage new franchisees. For example, a Cold Stone Creamery franchisee, when working with one of Cold Stone's preferred lenders, is only required to put down a 15% cash injection for the loan compared to the standard 30%. These programs won't entirely fund your franchise, but they provide a health incentive that gives you a strong advantage over the average small business. There's no downside to taking advantage of these programs, so if your franchisor offers them, make sure to utilize them.

Friends, Family and Fools
The fools part may sound a bit harsh, but this is the industry term for self-funding a franchise with a group of friends or acquaintances (or the fools, being someone you don't know who'll just hand over his money to you). This can be a great way to avoid the burden of a bank loan, have some breathing room with your cash flow and limit your personal liability by dividing the investment among several parties. Important things to keep in mind are that even though its friends and family, you still want to layout everything in writing, so there's no conflict or ambiguity down the road. Also, make sure you carefully think through exit strategies for each investor. A small business can go south in a hurry if one investor decides to pull back his investment, thus crippling your cash reserves.

There's no 'right way' to fund a franchise, but knowing all of the options and the pros and cons of each will help you and your investors make an educated decision. If you're still in doubt, get in touch with your franchisor. They have plenty of experience helping people get started and will be glad to walk through all of your options with you.