During financial downturns, entrepreneurial ventures like franchises seem to be an easy way to achieve success. After all, chains have the power of brand-name recognition and a reputation for consistency among consumers. But franchising is not necessarily as stable as you might think.
Certain franchisees are defaulting on Small Business Administration guaranteed loans. Ten of the worst franchise defaulters collectively failed to pay back $121 million in Small Business Administration guaranteed loans from 2004 through 2013, according to a Wall Street Journal analysis of chains whose franchisees have high failure rates on SBA guaranteed loans.
That figure is 21% of total franchise loan charge-offs, the analysis found.
These franchisees defaulted at more than double the average rate for SBA borrowers who invested in all other chains. The top franchise defaulter is Planet Beach with a 41.1% default rate amounting to a whopping $10.8 million. Other brands with high default rates include Huntington Learning Centers, Quiznos, Cold Stone Creamery, Aamco Transmissions, Curves International, Cici’s Pizza, Minuteman Press, Sylvan Learning and Cartridge World.
Franchises are not recession proof, and those that cannot bring in enough revenue will struggle to repay SBA loans. These types of businesses fail for many of the same reasons other small businesses do, including lack of experience, poor location, insufficient funding and sales, inadequate marketing, or a lack of support from the franchisor.
Prospective owners need to treat franchises like any other business venture, beginning with research. By obtaining a Franchise Disclosure Document, potential franchisees can be more informed about the company prior to signing an agreement. These documents include details on litigation, bankruptcy, territory, earnings claims, financial statements, fees and more.
Those who want to start franchises or other small businesses have several options to get funding that doesn’t involve putting their personal finances on the line.
Small Business Administration Loans
To obtain an SBA-guaranteed loan, businesses must first meet the criteria of a small business under the guidelines of the Small Business Administration. This means businesses must be independently owned and operated within the United States and cannot exceed limitations on the number of employees and amount of revenue it brings in annually.
Business owners can apply for an SBA loan through a local lender, including banks and credit unions. The SBA does not actually lend money; instead the administration works with lenders and guarantees repayment.
The most common SBA guaranteed loan is a 7(a) loan. You can use a 7(a) loan for financing a variety of short-term and long-term objectives, including operating costs, purchasing inventory and equipment, real estate, construction and more.
Other Small Business Financing Options
Beyond SBA loans, there are alternative means of finding funding for small businesses. Business owners can find low-interest loans through state and local economic development agencies as well as non-profit organizations.
Crowdfunding through platforms such as Kickstarter, Crowdfunder and Indiegogo enable small business owners to showcase their ideas to a wide audience of potential donors. Unlike loans, business owners don’t have to pay back the money they receive; they just have to provide rewards or equity to the donors.
For small business grants, owners can check with state and local programs, nonprofit organizations and other groups to find out what kind of programs are available. These grants usually require the recipient to match the grant amount through personal financing or a loan. The federal government does not provide grants for starting or expanding a business.
Find more information on small business loans with NerdWallet’s Small Business Loan Guide.
Franchise illustration via Shutterstock.