If you plan to buy into a franchise, you may be wondering about the SBA loan program you can use to cover the costs of a new business or franchise. Named after the Small Business Administration that guarantees them, these loans enable buyers to finance a large portion of their startup costs, working capital expenses, equipment needs, and building acquisition or improvement costs.
What kinds of loans does the SBA offer?
The SBA offers the 7(a) loan to small business and franchise unit owners to cover up to 90 percent of their startup costs, working capital, and equipment needs. A 7(a) loan cannot be used to cover franchise fees or royalty fees. However, franchise fees may count toward the 10 percent down payment that borrowers must make to attain an SBA loan.
Depending on your needs and the level of financing you require, you may consider one of the three types of 7(a) loans the SBA offers:
Standard 7(a) loan | |
| Maximum loan amount | $5,000,000 |
| Collateral requirements | Loans that are $350,000 or more are collateralized to the maximum extent possible. If a business’s fixed assets can’t fully secure the loan, lenders may include trading assets and will take the available equity in the owner’s personal real estate as collateral. Any shortfall may be covered by a life insurance policy that names the lender as the beneficiary. |
| Maturity terms |
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| Other terms and conditions | The SBA sets a maximum interest rate for the loan, and lenders and borrowers can negotiate the loan rate up to that maximum. Eligibility and credit decisions are determined by the SBA or certain preferred lenders. The loan turnaround time is generally 5-10 days. |
7(a) small loan | |
| Maximum loan amount | $350,000 |
| Collateral requirements | Loans between $25,000 and $350,000 are generally collateralized through a lien on the assets being financed with the loan proceeds and a lien on the applicant’s fixed assets. |
| Maturity terms |
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| Other terms and conditions | The SBA sets a maximum interest rate for the loan, and lenders and borrowers can negotiate the loan rate up to that maximum. Eligibility and credit decisions are determined by the SBA or certain preferred lenders. The loan turnaround time is generally 5-10 days. |
SBA express loan | |
| Maximum loan amount | $350,000 |
| Collateral requirements | Loans between $25,000 and $350,000 are generally collateralized according to the lender’s policy. |
| Maturity terms |
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| Other terms and conditions | The SBA sets a maximum interest rate for the loan, and lenders and borrowers can negotiate the loan rate up to that maximum. Eligibility and credit decisions are determined by the lender. The loan turnaround time is 36 hours or less. |
The SBA also offers the 504 loan program to cover the purchase of existing buildings, the purchase of land or land improvements, the construction of new facilities, the renovation of existing facilities, and the purchase of long-term machinery. Unlike 7(a) loans, 504 loans must be used for a specific purpose, which cannot include working capital or inventory or consolidating debt.
While 7(a) loans are provided by SBA-approved lenders, 504 loans are granted through a collaborative effort from participating lenders, SBA-regulated certified development companies (CDC), and borrowers. In most 504 arrangements, the SBA lends 40 percent of the total project costs. Lenders provide 50 percent of the total project costs, and borrowers provide the remaining 10 percent.
504 loan | |
| Maximum loan amount | $5,000,000; however, business owners are generally required to create or retain one job for every $65,000 the SBA guarantees |
| Collateral requirements | The financed project assets are often used as collateral, and personal guarantees from owners who have a 20 percent or greater in the business are required. |
| Maturity terms | 10-, 20-, and 25-year terms |
| Other terms and conditions | Interest rates align with the current market rates for 5-year and 10-year U.S. Treasury issues and are fixed for the life of the loan. |
Which loan program is right for me?
Whether you choose one of the 7(a) options or the 504 loan will depend on what you plan to do with the funds you raise. If you’re planning to raise capital for a specific real estate project, such as buying land or engaging in renovations, then you’ll likely choose a 504 loan. If you plan to fund other startup costs or working capital needs, you’ll choose a 7(a) loan or another financing option.
It’s important to note that some SBA loans include additional fees and prepayment penalties. You should speak with a lending officer before proceeding with an SBA loan to make sure that it’s a suitable choice for your needs and that your business is eligible for SBA funding.
What are the qualifications for SBA loans?
One of the most important qualifications of an SBA loan is that the franchise you’re attempting to purchase is SBA approved and listed in their franchise directory. Franchises that are not included in this directory are not eligible for SBA financing.
Other important qualifications include:
- The ability to make a down payment equal to 10-20 percent of the purchase price
- An inability to find other options for financing
- Solid financial footing
You can find additional requirements for the 7(a) loan options here and the 504 loan here.
Where do I go to attain one of these loans?
Many commercial, regional, and community banks issue all three forms of 7(a) loans, and they can guide you through the steps you’ll need to take to start the 504 loan process. Most will direct you to the appropriate contact at a certified development company (CDC) in your region.
Some online banks also offer these loans. GoKapital and Commercial Loan Direct are two popular lending services many business owners use to access SBA financing.
What should I do before applying?
There are four steps you should take before applying for an SBA loan for your franchise:
1 | Make sure your finances are in good order.You and any partners who will hold at least a 20 percent ownership share in the business should gather three years of tax returns, determine your net worth, and ensure that your credit scores are 650 or greater. | ||
2 | Develop a plan for covering the down payment.As a borrower, you’ll be expected to make a down payment that equals at least 10 percent of the business’s acquisition cost. You may choose to dip into your personal savings, stock accounts, home equity accounts, or retirement funds to accumulate the cash that’s needed, or you could consider leveraging the assets of another business you might own.
You may wish to speak with a certified public accountant (CPA) or financial planner who can help you understand the risks of using each of these sources of funding.
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3 | Select an SBA loan provider.You can work with any commercial or community bank that offers this service, but you may want to choose one that has a team dedicated to serving small businesses and offers favorable terms and competitive interest rates. GoKapital and Commercial Loan Direct are popular SBA lenders.
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4 | Gather the documents you’ll need to complete the application.You’ll need to gather or create personal and business documents to demonstrate your business’s viability, your creditworthiness, and your ability to run the business effectively. Key items include:
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How do I apply for an SBA loan for my franchise?
Your lender will provide you with a loan application and SBA forms specific to the loan you’re seeking for your franchise. You will complete SBA Form 1919 and SBA Form 413 for the standard 7(a), 7(a) small loan, and SBA express. You’ll also complete SBA Form 1920 for the standard 7(a) and the 7(a) small loan. For the 504 loan, you will complete SBA Form 1244.
Important note: Your lender may ask you to purchase creditor insurance, which provides assurance that the loan will be repaid in the event of your death or incapacity. Learn more about creditor insurance in our Small Business Financing 101 article, What Is Creditor Insurance?.
Once you complete the required forms and show you can provide collateral, the lender will begin the underwriting process. During this time, the lender will evaluate your assets, liabilities, and managerial experience and assess the business’s financial positioning.
If your lender is an SBA-preferred lender, the team you’re working with will decide whether to approve the loan. Others will need to work through the SBA for loan approval. If your loan is approved, the lender will work quickly to distribute the funds you need to purchase your franchise unit.
How can I boost my chances of being approved for an SBA loan for my franchise?
Here are some strategies you can use to boost your odds of approval:
- Make sure your franchise is eligible for an SBA loan before starting the process.
- Check your credit score before applying to make sure it is 650 or greater.
- Arrange a free meeting with a SCORE mentor to finetune your business plan and ensure that it contains the information you need to explain the business, demonstrate how you’ll use your skills and experience to manage it, and describe your plans to repay the loan.
What else should I know?
SBA loans aren’t your only funding option. Read Your Go-to Guide for Financing the Purchase of a Franchise to find more ways to access capital, which can include term loans, asset-backed loans, retirement plan access, and franchisor financing.
Need more support? We can help. Log into your owner’s portal for a step-by-step guide, resources, and articles that’ll help you to find a franchise, attain financing, and conduct the work that’s needed to make your venture a success.
