Financing Your Franchise Through The SBA

By Joseph Lizio

Posted : November 9, 2011

Category : How To

Financing Your Franchise Through The SBA

Buying into a franchise is one of the quickest and easiest
ways to jump into the business world – especially for potential entrepreneurs
that may not have the skills or creativity to develop their own business concept.

Buying into a franchise can also give a new business owner a
huge leg up on their non-franchise competitors as much of the initial struggles
of starting a business, like brand development, strategic planning and market
research, to name a few, usually takes years to complete and perfect – not to
mention an enormous amount of expense. 
But, when buying into a franchise system, these challenges have already been
completed by the franchisor.

Further, franchisees realize a tremendous competitive cost advantage
via bulk purchasing through their franchisor, marketing support (even locally)
and access to low cost equipment and construction resources.

Nevertheless, franchisees still face many hurdles; one in
particular – financing. 

These business owners are still at the mercy of the
financial industry when it comes to obtaining the financing needed to initially
purchase a franchise or for growth capital in an established franchised business.

In any market, financing a small or new business is
difficult.  Add in a poor or sluggish
economy and difficult can become impossible.

While franchises have many benefits for entrepreneurs, banks
and other lenders tend to look at them as if they are any other business and
thus focus their underwriting on adequate cash flow, collateral and credit when
approving funding.

However, and with increased activity over the last few
years, the Small Business Administration (SBA) has developed a streamline
financing program that pre-screens franchise programs to speed up the application
process for SBA backed funding.

Good news for franchises.

SBA Financing

The SBA, regardless of business type, has three main lending
programs – two of which we will focus on here. 
The third program is their Micro Lending Program which can provide up to
$35,000 for new businesses and up to $50,000 for established businesses.

Do know that through any of the SBA’s loan programs, the SBA
does not make direct loans to business owners. 
Their programs are designed to facilitate small business lending in the
market by leveraging existing lendable dollars.

Thus, the SBA only guarantees these loans.  The idea is to entice banks and other lenders
to take a little more risk in providing business loans to borderline borrowers – borrowers that may not fully meet the lender’s loan policies but that still
have upside potential – like franchises.

Therefore, even though a business borrower may apply for and
receive what is called a "SBA loan"; these loans must still be underwritten and
approved by a qualifying bank or lender before being guaranteed by the SBA.

7(a) Loan Program

The SBA’s premier program is their 7(a) loan program.  This program is designed to help business
owners either purchase a new business (either new outright or just new to the
borrower) or expand an existing business. 
Loans can be used for purchasing or constructing buildings, purchasing
new equipment and machinery or working capital for seasonal businesses or
inventory centric businesses.

In most cases, the SBA will guarantee up to 90% of the loan
amount – still requiring the borrower to provide at least 10% in equity (cash
or value).

Further, under the 7(a) program, the SBA offers specialty subprograms
designed for businesses (including franchises) that export products, operate in
underserved rural areas or for specially groups like veterans and military

504/CDC Loan Program

The SBA’s 504/CDC loan program is a three party business
loan program that works as such:

1) A loan secured from a private bank or lending institution
for 50% of the project’s cost.

2) A loan secured from a Community Development Corporation
(CDC) for 40% of the project’s cost.

3) The reaming 10% provided by the business owner

These loans can be use for almost everything that a 7(a)
loan can be used for with the major exception being working capital.  The idea here is that the banks, CDCs and the
SBA want to further secure these loans with high value collateral like property
and equipment.

Pros and Cons of SBA

Benefits of SBA Guaranteed Loans:

  • The
    main benefit is allowing business borrowers (even franchisees) to access
    capital to start, buy or expand a business; capital that they might not be
    able to get anywhere else.
  • Fixed interest
    rates.  Most standard or traditional
    business loans are variable rate facilities.  The reason is that banks and other
    lenders want to ensure that should their costs of funds rise, they do not
    get upside down in these loans.
  • Capped
    interest rates. The SBA caps the interest rates on the loans it
    guarantees.  It does not set the
    actually rate as that is negotiable between the lender and the
    borrower.  But, the SBA does set the
    maximum amount that a lender can charge.
  • Long-term
    financing.  Most SBA loans are
    termed at 10 to 25 years.  While interest
    rates can play a major part in the affordability of a loan, longer terms
    play a bigger roll in reducing the monthly payment amount many times
    being the only issue that can keep a payment inline with the business’s cash
    flow numbers.

Benefits specifically for franchises: The SBA really likes
to back franchisees. The main reason is that these entrepreneurs are not in business
by themselves.  They have a huge support
network, a tried and true business model and ready made customers who already
know and understand the brand.  This is a
home run in the business world and provides the SBA with some assurance that
the franchise will be a success.

The Downside Of SBA Loans:

  • Time.  SBA loans take time as they have to be
    underwritten by both a lender and the SBA. 
    And, since the SBA is part of the government, their portion can
    take a substantial amount of time.
  • SBA
    loans can have higher initial fees (in additional to interest rates) as
    the SBA also charges to underwrite the loan request and collects a fee to
    replenish the guarantee fund. 
    However, most of the SBA’s fees can be financed into the loan.
  • These guaranteed
    loans still have to be approved by a bank or qualified lender.  And, if these lenders are not making business
    loans, it doesn’t matter how much the SBA guarantees.

As stated, the SBA keeps a list of pre-screened
franchises.  However, just because your
franchise is not listed does not mean that the SBA will not back it.  It only means that your application process
for a SBA business loan may be extended; giving both the lender and the SBA
time to qualify the franchise, its system and you, the borrower.

If you are thinking about buying into a franchise but are
worried about financing (in the beginning and as the business grows), take a
little time and see if a SBA guarantee loan program will work for you.  You just never know what you might find and
finally be able to realize all your business or franchise dreams.

For more information about the SBA’s business loan programs,
visit the SBA’s website or talk
to your local bank (just remember that not all banks offer SBA loan programs,
so shop around).

About the author:

Joseph Lizio holds a MBA in Finance and Entrepreneurship, is the founder of Business Money Today, has a strong commercial lending background and is regarded as an expert in business and finance - specifically business loans and working capital.