When you open a franchise storefront, the parent company, or franchisor, sells you the right to its business name, product and brand. The franchisee agreement lasts for a certain length of time, up to two decades, but you can usually renew.
What do you get out of this arrangement? You’re starting a company with an established brand and proven business model. The downsides: You give up control of business decisions to the franchisor, including site approval, design standards and product variation. You also have to foot the startup costs, so finding good financing is crucial.
Below, we outline the costs of funding a franchise and some good sources of financing, depending on your personal credit, whether you’re just starting out or funding growth, and other factors. Here’s what you need to know:
- Costs of opening a franchise
- Where to find financing to open a franchise
- Where to find financing for a growing franchise
Costs of opening a franchise
Starting a franchise requires many of the same expenses as starting any other brick-and-mortar business, including real estate, equipment and inventory. Franchisees, however, have to pay some unique costs in exchange for training, operating guidelines and marketing from the parent company.
Franchise fee: Most companies charge an upfront fee to start a franchise, paid in a lump sum or installments. The amount varies by company, but it’s typically tens of thousands of dollars and usually is not refundable once a franchisee is accepted. For example, Jamba Juice charges $25,000 per store, and Hilton Worldwide charges $75,000 to start a 150-room Hilton Garden Inn.
Royalty and advertising fees: Many franchisors also collect recurring royalty and marketing fees, typically a percentage of a franchisee’s sales. These percentages vary by company. For example, Subway franchise owners pay 8% a week in royalties and 4.5% a week for advertising, taken from the store’s gross sales minus sales taxes.
For specific companies’ franchise fees, refer to the Franchise Disclosure Document, which the Federal Trade Commission requires parent companies to give to prospective franchisees. This file also includes information about the franchisor’s financial performance, franchisees’ obligations to the franchisor and financing options available.
Where to find financing to open a franchise
As with other small businesses, finding financing for a new franchise can be one of the biggest challenges owners face. Some financing options are unique to franchises, such as franchisor discounts on fees and online financing companies that cater to franchises. General business financing options such as traditional and Small Business Administration loans are also available to franchisees.
The franchisor: Some franchisors help finance new franchises by waiving fees or partnering with lenders to help franchisees get loans. If a company offers funding, it’s usually listed on its website and in Section 10 of the Franchise Disclosure Document. Compare the terms of the franchisor’s financing with other options to find the best source of funding.
Franchise financing company: Several companies specialize in franchise funding by matching borrowers with lenders or lending directly. Examples include BoeFly, which has helped Dunkin’ Donuts and Great Clips franchisees get funding, and Franchise America Finance, which funds franchises including Corner Bakery Cafe and FastSigns.
Traditional loan: Banks and credit unions are a source of financing for all businesses, including franchises. New franchise owners are 15% more likely than other new business owners to use a commercial bank loan, according to the SBA. Lenders are more likely to finance franchises of an established brand that has proved successful in a variety of markets. However, you’ll still be subjected to the bank’s underwriting standards and lending policies, meaning it will review your net worth and credit history. You also may need to put up collateral, regardless of the brand you’re associated with.
SBA loan: The SBA guarantees several loan products that banks, credit unions and other lenders issue, including 7(a) loans, the most general and commonly used loan type. Franchisees and other small-business owners can apply for SBA loans through their lender.
Thousands of companies, including Ace Hardware, Papa John’s Pizza and Yogurtland, are on the SBA’s franchise registry. Applying for a loan to start a franchise for a company on that list is faster than normal because the SBA already has reviewed those companies and their franchise agreements.
Where to find financing for a growing franchise
Alternative lenders: Once you have your franchise up and running, you’ll need funding to work through seasonal ups and downs, purchase new equipment and possibly open another location. If you’re still having a hard time finding traditional funding, alternative lenders may help fill the gap. They tend to be quicker than traditional loan providers — some even fund within a day — and have looser qualification standards. However, annual percentage rates for alternative lenders typically are higher, so make sure you review your total cost of borrowing before deciding on a loan.
- If you’ve been in business for a year: As a newer franchise, you’ll want to make sure you have money to cover the basics, such as emergency funding and inventory, before you start focusing on growth. OnDeck and StreetShares both offer financing to businesses at least a year old, and OnDeck’s line of credit is an option after nine months. If your personal credit is 600 or more, StreetShares has a line of credit and a term loan for 9% to 40% APR. Another option is OnDeck’s line of credit, which has an APR of 13% to 40%. OnDeck also offers a term loan for people with credit scores starting at 500. The lower your credit score, however, the higher your APR will likely be. The term loan ranges from 9% to 99% APR.
- If you have an established franchise: Even after you’ve cemented your place in the franchise world, you’ll still likely need access to funding, especially if you want to open another location. SmartBiz and Funding Circle offer financing to restaurants that have been in business at least two years. SmartBiz helps owners connect with SBA loans, which provide the lowest APRs — 8% to 8.7% — on the market. Funding Circle’s rates are competitive compared with other online lenders, from 7% to 36%. You’ll need good credit to qualify for both options, but Funding Circle doesn’t have a minimum revenue requirement.
For more small-business loans, compare your options:
Updated Feb. 21, 2017.