Franchises and SBA Loan Funding
Starting a new business can be intimidating. You have to study and keep up with the market, plan several years ahead, build a customer base and branding, fund your venture, and more—all while running day-to-day operations.
How about franchising instead? Buying into a franchise is like starting a business with training wheels. If you’re not quite ready for building a business from the ground up—or if you’d simply like some extra support—then a franchise might be just what you’ve been looking for.
But like any business, buying into most franchises requires money. If you’re wondering how to get a loan to start a business or franchise, there are fortunately small business loans out there to assist you, like an SBA loan. SBA loans are an excellent choice to acquire working capital, buy equipment, or purchase real estate for a franchise. And although some types of SBA loans require prior business history or experience, others are designed specifically for those new to their business journey.
Ready to learn more about getting an SBA loan for a franchise or business? We’re taking a look at the whole process, from what the SBA is to top franchises funded by SBA loans.
What Does SBA Loan Stand For?
The SBA stands for the U.S. Small Business Administration, which provides loans tailored to small businesses. Their mission is “to aid, counsel, assist and protect the interests of small business concerns, preserve free competitive enterprise and maintain and strengthen the overall economy of our nation.” They’ve been doing this since 1953 as an independent agency of the federal government.
Small business loans through the SBA offer many benefits (like lower interest rates) over a conventional loan, making it an appealing option for newer or smaller businesses.
Of note, the SBA does not issue loans directly to borrowers. Instead, they work with lending partners to provide these funds. SBA lenders must meet numerous requirements to participate in these loan programs, such as passing a rigorous evaluation and meeting certain ethical requirements described in the Code of Federal Regulations.
What Are the Types of SBA Loans?
The SBA offers a variety of loan options for small businesses and franchises, including:
- SBA 7(a) Loans
- SBA CDC/504 Loans
- SBA Microloans
Which SBA loan route should you choose? Let’s explore the basics of each option.
SBA 7(a) Loans
- An SBA 7(a) loan is one of the most popular SBA lending options available.
- These are commonly used to purchase a business, restructure debt, get working capital, etc.
- The maximum loan amount is generally $5 million.
- There are many types of 7(a) loans that provide different benefits, such as the SBA Express Loan (which features accelerated turnaround time for review) or the Veterans Advantage Loan (which offers reduced fees for veteran-owned businesses).
- The length of loan terms vary, ranging from up to five years to up to 25 years.
SBA CDC/504 Loans
- These are commonly used to purchase heavy machinery/equipment or commercial real estate. You cannot use CDC/504 loans for working capital, inventory, or restructuring debt.
- The maximum loan amount is generally $5 million. However, borrowers can receive up to $5.5 million for certain energy projects (for up to three projects).
- SBA CDC/504 loans are available through Certified Development Companies (CDC), which are non-profit partners with the SBA “focused on promoting community economic development through 504 loans programs.”
- The length of loan terms vary, ranging from up to 10 years to up to 20 years.
- These are commonly used in ways similar to the 7(a) and CDC/504 loans, but on a smaller scale. However, there are restrictions—you cannot use an SBA microloan to pay existing debts or purchase real estate.
- SBA microloans are an excellent choice for new franchisees, as they are designed for startups.
- The maximum loan amount is generally $50,000.
- The length of the loan term is much shorter, capping out at six years.
Can You Use an SBA Loan for a Franchise?
Yes, you can use an SBA loan for a franchise, but there are a few things to consider before choosing this route.
Before diving in, let’s have a quick refresher on what exactly a franchise is. Investopedia nicely sums up the definition of franchise: “A franchise is a type of license that grants a franchisee access to a franchisor's proprietary business knowledge, processes, and trademarks, thus allowing the franchisee to sell a product or service under the franchisor's business name.”
It’s kind of like baking a cake from a box versus baking a cake from scratch. With a franchise, you get all the knowledge, products, and plans to run a business, like a prepackaged cake mix that has been fine tuned to produce the best cake. When you create your own business, it’s like baking the cake from scratch—sourcing your own supplies and resources, creating brand awareness, and developing the perfect recipe for success.
With these differences come a few additional SBA loan requirements as a franchisee. For example, you cannot use an SBA loan for a franchise unless it is included in the SBA Franchise Directory. A franchise must submit an application and go through a thorough review process before the SBA will add them to this directory.
Also, the franchisor cannot have power to control the franchisee’s operations in a way similar to an employment contract to be eligible for an SBA loan. This relationship between the franchisee and franchisor must be clearly laid out in the Franchise Disclosure Document—a legal document that the Federal Trade Commission (FTC) requires all franchisors to provide to prospective franchisees.
Who Qualifies for an SBA Loan?
As with most loans, you must meet certain SBA loan requirements to qualify, such as having good credit and working in an eligible industry. Each type of SBA loan will have specific conditions, but we’ll review some of the more common ones to qualify for an SBA loan.
SBA Eligibility Checklist
To qualify for an SBA loan in general, a business or franchise must:
- ✓ Be Located in the U.S. - The business must be physically located or doing business in the United States or its territories.
- ✓ Be an Eligible Business - There are certain ineligible businesses that will not qualify, such as those engaged in illegal activities, dealing rare coins and stamps, speculations, lending, pyramid sales plans, gambling, religion, charity, and more.
- ✓ Be For-Profit - SBA loans are only available to for-profit businesses.
- ✓ Be Invested - The business owner must be reasonably invested (via time and/or money) to be able to operate on a durable basis.
- ✓ Exhaust Other Financing Options - You cannot be receiving funds for your business from any other financial lender. Some lenders may require proof that you have attempted and failed to finance elsewhere before applying for an SBA loan.
- ✓ Meet Size Requirements - It isn’t called the Small Business Administration for nothing, and a business must be considered small to qualify for an SBA loan. However, each industry has its own definition of “small” set by the SBA. For example, a dog and cat food manufacturer can only have up to 1,000 employees to qualify for an SBA loan, while an electronic computer manufacturer can have up to 1,250 employees and still qualify.
What Do SBA Loans Look For?
If you meet the above SBA eligibility criteria, you must next consider the additional requirements set by lenders. Some lenders will have stricter rules than others for approving an SBA loan, but here are what most lending agencies will be looking at when evaluating your application:
- Personal Credit Score - There is no specific credit score range set by the SBA to qualify for small business financing, but lenders will always look at your credit score. Generally, to meet a lender’s SBA loan requirements for credit score, a score around 680 or above is considered good. It’s not impossible to get an SBA loan with a slightly lower score, but it might be harder to find a lender.
- Business Credit Score - Lenders will sometimes look at your business credit score in addition to your personal credit score. The FICO Small Business Scoring Service (SBSS) is the most common way to evaluate business credit history, as it allows lenders to “reliably and consistently minimize the data, time, and expense of assessing a small business applicants’ credit risk.” The range is from 0 to 300, and around 155 is usually the threshold for approval if lenders have this requirement.
- Current Financial Status - How’s your current annual revenue? What are your cash flow projections? Do you have existing business debts and loans? This kind of information is also important to lenders. They want business owners with a smaller Debt-to-Income (DTI) ratio, as that demonstrates how affordable debt repayment is for the borrower.
- Collateral - Collateral is what you provide to the lender as a guarantee of your repayment of the loan. For example, if you take out a mortgage, your agreement with the lender will typically state that the lender gets your house if you fail to pay. An SBA 7(a) loan, for example, only has SBA collateral requirements for loans in excess of $350,000, and other SBA loans do not require any collateral.
- Time You’ve Been in Business - The SBA does not have a required amount of time you must be in business before applying for an SBA loan, but some lenders will have requirements, the most common being two years. If you haven’t been in business for two years, not to worry—it is possible to find a lender to work with you if you are a newer business. The SBA microloan and Community Advantage loans, for example, are designed for startups.
Are SBA Loans Hard to Get?
SBA loans can be challenging to qualify for, but the benefits make the process worth it. Lenders will examine many facets of your life and your business before approving you for a loan. A few issues that cause lenders to deny SBA loan applications include:
- A Criminal Record - The personal history SBA loan application form requires that applicants disclose specific information about any criminal history. Certain responses will halt or delay the application process.
- Poor Credit - Borrowers should aim for a credit score in the mid-600s before applying.
- Default on Government Loan - Having unpaid or delinquent government loan debt will usually make you ineligible to apply for an SBA loan.
What Do I Need for an SBA Loan Application?
You’ll need to gather documentation for your business when applying for an SBA loan. It’s helpful to run through a checklist beforehand and ensure everything is organized and ready to be submitted. This preparation will help speed the application and review process along.
Here are some common documents you can expect to submit for an SBA loan application:
- Business plan
- Proof of current financial status
- Profit and loss statement
- Projected financials
- Business license or certificate
- Owner criminal background checks
- Basic owner information, percentages, and affiliations
- Statement of personal history
- Real estate documents such as purchase agreements
- Franchise documents
- Lease agreements
- Environmental reports
- Owner resumes
How Is the SBA Loan Calculated?
Many lenders will use (or provide you with) with an SBA loan calculator to determine what your monthly payment might be. This is especially helpful in the planning stages when you’re figuring out what loan amount fits into your business budget.
SBA loan calculators will need information like:
- The loan amount you plan to borrow
- The interest rate
- Any application fees
- The loan term (some in months, some in years)
- Any monthly service charges
Can You Apply Online for an SBA Loan?
You can begin the application process for an SBA loan online with most lenders. To begin, first find a lender that specializes in SBA loans. The SBA has tools on their website to match you with the best lender for your needs. After answering a few questions online, you will receive an email from the SBA with information of interested lenders you can contact.
It’s always a good idea to reach out to multiple lenders. This allows you to compare rates and eligibility conditions so you can get the best deal and fit for your business. And if one lender doesn’t approve your loan, you can always apply through another lender you contacted who may have different requirements.
How Are SBA Loans Paid Back With a Franchise?
SBA loans for franchises are paid back similarly to many other loans—by making fixed, monthly payments over a set period of time, with interest. To make a payment on an SBA loan, you can either pay online, through your personal banking bill pay, or by mailing in a payment.
Many franchisees are attracted to the SBA loan because these programs encourage small business financing with longer repayment periods (some up to 25 years). This helps to keep loan payments smaller and more manageable, which is especially beneficial for those new to franchising. The SBA also caps interest rates for lenders—keeping interest affordable for borrowers—and offers low down payments and business counseling support.
Top Franchises Funded the Most by SBA Loans
If you’re not sure which franchise to pursue with an SBA loan, it can help to look at those who have had success before you. One study on SBA loan data over a period of ten years ranked the top SBA funded franchises. Some of the franchises that made the cut include:
- Jimmy John’s
- Anytime Fitness
- Sport Clips
- Little Caesars
- The UPS Store
- Firehouse Subs
- Orange Theory Fitness
- Dairy Queen
Check Out More Franchises With Franchise Gator!
Ready to be your own boss without the common stressors of traditional business ownership? Then franchising might be the answer you’ve been looking for. You’ll have the freedom to run your own schedule and be your own boss, all with the experienced knowledge and support of a franchisor. Plus, you’ll start out with increased brand awareness and have options like the SBA loan available for funding.
Why not start this new journey today? Head on over to our Franchise Gator listings to do your research and find franchise options that speak to your passions and interests.
Most Popular Industries & Categories
As of January 25, 2021:
- Food, Dining, & Restaurants
- Home-Based Businesses
- Low Cost Franchises
- Covid-Resistant Franchises
- Gas Stations
- Self Storage Franchises
- Vending Machine Distributors
- Automotive Shops
- Retail Stores
- Business & Commercial Services