When it comes to financing a franchise opportunity, loans are one of the most common sources of capital. Many commercial and community banks offer three kinds of loans you might consider for your new franchise: term loans, asset-backed loans, and SBA 7(a) loans.
This article focuses on one of these kinds of loans: a term loan.
What is a term loan?
A traditional term loan is an arrangement you make with a lender to borrow a specified amount of money for a specific purpose for a set period of time. Your lender will set terms, and you will agree to repay the loan with fixed, equal payments and a preset rate of interest.
Term loans generally have favorable terms and long repayment schedules (up to 10 years). This makes them a great option for owners looking to cover part of their startup costs. However, they are notoriously difficult to qualify for.
|If you can't meet the qualifications of a traditional term loan, consider online term loans. These loans often have less stringent credit score and credit history requirements.
Keep in mind that many online term loans have less favorable terms than loans offered by conventional lenders. These lenders often quote higher interest rates and offer significantly shorter repayment terms than traditional term loan lenders.
Can I borrow the full amount of money I need to raise to start and operate a franchise unit?
Generally, no. Many franchisors require prospective owners to have a minimum amount of non-borrowed cash on hand to invest in the franchise and cover the franchising fee. However, a term loan can be used to cover some of the other costs of starting a franchise, including acquiring the real estate, equipment, inventory, or working capital that’s needed to run the business.
What qualifications will I need to meet?
To qualify for a traditional term loan, you’ll need:
- A strong personal credit score (generally 700 or higher)
- A source of funding to cover a down payment, which may be up to 30% of your capital requirements
- Verifiable management and industry experience
If you already own a business—and that business will play a role in the purchase of your new franchise—you’ll need to demonstrate a few more qualifications, including:
- A favorable business credit score
- Good credit history
- Positive cash flow that signifies your business’s ability to support the debt that it’ll take on
How do I apply for a term loan for my franchise?
Determine which commercial banks, community banks, and credit unions in your area offer term loan options for franchise owners. Then, inquire about their rates and qualifications. If you qualify and are comfortable with the terms and interest rate a lender offers, you can begin the application process.
Start by gathering the documents they request. Often, these will include:
- Three years of personal bank statements, tax returns, and financial statements
- Your credit report and the credit reports of any others who will own 20 percent or more of the franchise unit
- Verification of the amounts and sources of other capital you plan to use to attain the franchise
- Your business plan, which should describe how you’ll run the business and ensure its profitability
- A statement that explains your management and industry experience
- A statement that explains how you plan to use the proceeds of the loan
You’ll also be asked to provide a copy of the Franchise Disclosure Document (FDD), which will provide your bank’s loan officers with the following information:
- A description of the business
- Verification of the business’s articles of incorporation
- Resumes of the franchisor’s principals or partners
Additionally, you’ll need to provide financial information and projections. These may include:
- Cash flow projections
- Projected profits or losses
- Balance sheet information
- Profit and loss statements
- Business tax returns for the last three years (if applicable)
- A schedule of the business’s term debt
- A third-party valuation of the collateral you plan to put up or an audited copy of your balance sheet
- Verification of your ability to make a down payment
Will I need to provide other documentation?
If you have established a business entity to acquire the franchise unit, you will also need to provide up to three years of business tax returns, bank statements, and financial statements and your business’s current debt schedule and repayment priorities.
If your loan request includes construction or leaseholder improvements, you’ll need to provide additional documentation, which may include a construction contract, a tax appraisal, and a third-party appraisal of the land or current property.
Who can help me with this documentation?
You’ll need an accountant and a valuation specialist to fulfill some of these requirements.
Here are a few accounting firms worth considering. Check them out here (and be sure to click the logo to learn more about them):
Next, you’ll complete your lender’s application. You can speed through the remainder of the loan process and boost your chances of approval by completing the application in its entirety and by being responsive to your lender’s questions and requests for clarification.
|You can apply for a term loan at multiple institutions to improve your odds of securing the capital you need to open a franchise unit.|
Review the offers you receive carefully. Make sure you understand the terms, conditions, and risks of the loan (which may include losing any pledged collateral upon default) before signing any additional paperwork.
A quick 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 disability, but they're prohibited from making it a requirement. You can learn more about creditor insurance here:
What should I do if my application is rejected?
Listen to your lending officer’s explanation, and ask for feedback on what you can do to position your request more favorably in the future.
Your lender may recommend simple tweaks to your business plan or a boost to your credit score to increase your odds of approval, or they may point to larger issues that you’ll need to resolve before reapplying for funding. You can make the necessary adjustments and submit a new application, or you can choose to apply with other traditional lenders or online term loan lenders who may be more lenient in their requirements.
Is a term loan the best option?
Like other forms of financing, term loans have advantages and disadvantages you should consider carefully:
(+) A term loan may help you attain all the capital to buy a franchise you need in a single transaction.
(+) Term loans allow you to spread the cost of your acquisition over a longer period of time than you can through many other financing options.
(+) These loans can help you build credit for your business, which is essential for attaining better financing options for future capital needs
(-) Term loans can be difficult to attain.
(-) The loan process can be lengthy.
(-) Lenders may require collateral to secure your loan, which can result in loss of personal assets or property in the event of default.
Looking for more support in starting a franchise unit? We can help. Log into your owner’s portal for articles, checklists, and advice you can use to make your venture a success.