The Pros & Cons of SBA Loans for Franchise Business Funding
Opening a franchise business can be a lucrative opportunity for aspiring entrepreneurs looking to invest in a proven business model. However, the steep initial investment it requires can often be a barrier to entry. That’s where franchise business funding comes into play. Franchise business funding provides entrepreneurs with the financing needed to launch a new franchise or grow an existing one. With a variety of funding options available, it’s important to identify the ideal type of financing based on your unique needs.
In this blog, we’ll dive into the various types of franchise business funding and analyze the advantages and drawbacks. Whether you’re a first-time franchise owner or seeking to expand your current operations, this blog has got you covered with all the crucial information on the topic of franchise business funding.
What Is Franchise Business Funding?
Franchise business funding empowers entrepreneurs to acquire a franchise or expand an existing one. Financing tailored specifically to franchise businesses offers a wide range of benefits, such as access to capital directly from franchisors, online lenders or traditional banking institutions. As franchisors have deep knowledge about their unique franchise model, they can provide customized financing solutions to franchisees. In the case of U.S. Small Business Administration loans typically provided by banks, the approval process can be cumbersome but borrowers can secure up to $5 million in a lump sum to acquire a franchise. Alternatively, financing from non-bank direct lenders can be provided quickly on shorter terms to meet unexpected cashflow issues.
The process of securing franchise business funding involves meeting specific qualification requirements, which vary depending on the lender, financing type and use of proceeds. The approval process can take anywhere from five minutes to 30 days, and borrowers may be required to put down some equity upfront. In some cases, as much as 10% to 30% of the total project cost.
Regardless of the funding option, it’s essential for you to carefully weigh your options before deciding on the financing method that is most closely aligned with your needs.
Common Franchise Business Funding Options
When it comes to franchise business funding, finding the right type of loan is crucial. For those who are just starting out, certain types of funding may be more suitable, whereas others may be better suited for those who are looking to expand or require assistance with operation expenses. Ultimately, the ideal funding solution will depend on your specific needs and circumstances, but proper financial planning and careful consideration of all available options are key to success.
Let’s take a closer look at some of your options.
Franchisor Financing – Some franchisors simplify funding by assisting new franchisees with loans and providing fee discounts. This type of offering is exclusive to certain franchises, and not all franchise business owners can benefit from this type of assistance. To find out if financing is available through your franchisor, visit the franchise company’s website and review the franchise disclosure document for relevant information on financing.
Non-Bank Direct Lenders – Through this option, borrowers have the convenience of applying online without visiting a physical bank branch. These lenders offer a streamlined online application process. Loans are typically available up to $1 million, and like traditional bank loans, borrowers receive a lump-sum disbursement. This option is ideal for borrowers who may be struggling to secure traditional bank financing or for franchise owners who need efficient funding.
Rollovers Business Startup (ROBS) – ROBS enables individuals to withdraw money from a 401(k) or other retirement savings accounts to finance a new business without penalties. However, rollovers come with risks if not executed properly, and while they are legal, the IRS considers them questionable.
SBA 7(a) Loans – If you already own a franchise or are thinking about buying one, you could be eligible to fund your business with an SBA 7(a) loan. This government guaranteed loan program is equipped with a variety of benefits, making it a viable option for franchise business funding. For reference, approximately one in every five SBA loans are authorized to a franchise business.
With a handful of options available, it’s worth noting that two options have certain restrictions. Starting with franchisor financing, as it relies on the framework established by the franchisor. In addition, ROBS necessitates a 401(k) and involves taking money out of personal savings. That said, for the purpose of likely comparisons, let’s examine the advantages and disadvantages of SBA loans in relation to online term loans provided by non-bank direct lenders.
The Pros of SBA 7(a) Loans for Franchise Business Funding
Pro #1: Extended Repayment Terms
Your franchise business can greatly benefit from SBA 7(a) loans through repayment terms up to 10 years, when used for working capital, equipment or debt refinancing, or even 25 years, when used for real estate. These repayment schedules provide a significant cash flow advantage. With longer repayment terms compared to the typical 12-24 months offered by non-bank direct lenders, you have more time to pay off your loan, allowing you to invest more in your franchise operations. Additionally, longer terms also means lower monthly payments, which can help maintain financial stability and ensure other expenses will be met.
Pro #2: Lower Interest Rates
One of the benefits of securing an SBA loan is the maximum interest rate threshold which is set by the SBA. As these loans are backed by the Federal government, they are designed to foster economic growth and development and therefore have restrictions in place to ensure that franchise business owners receive fair and competitive terms for their loans.
Although non-bank lenders set their own interest rates, they must still abide by state rules and regulations regarding usury laws. Such regulations are put in place to protect borrowers and ensure that lenders provide fair and equitable terms to their clients. This means that while online term loans may have higher interest rates than SBA loans, they are still subject to legal restrictions.
Pro #3: Flexible Uses of Proceeds
SBA 7(a) loans offer incredibly flexible uses of proceeds, providing well-rounded financial support to help you as a franchise owner achieve your goals. Unlike online term loans that are usually restricted to only working capital, SBA loans can be used to purchase new equipment, refinance current debt, buy real estate or even take advantage of working capital. This level of flexibility is a huge benefit that you can leverage in order to overcome financial obstacles and effectively scale your operations, which is crucial when running a business.
The Cons of SBA 7(a) Loans for Franchise Business Funding
Con #1: More Required Documentation
One of the most notable drawbacks of the SBA loan program is its heavy reliance on documentation. The requirements demand submission of an overwhelming amount of paperwork that can exhaust applicants and take away valuable time as a business owner. Furthermore, even the slightest error in the documentation can cause a delay or even the rejection of the loan application altogether.
On the flipside, online term loans from non-bank lenders require very few documents since they do not require collateral, are equipped with shorter repayment terms and have fewer eligibility requirements compared to SBA loans.
Con #2: Longer Application Process
The application process for SBA loans is notoriously lengthy and complex. According to data from BankRate, the average time it takes to complete an SBA loan application is around 30 hours. This means that franchise business owners looking to access funding quickly may find their options limited with SBA loans.
Unlike SBA loans, which can take weeks or even months to process, online term loans can be approved in as little as 24 hours. This is especially important for franchise businesses when they are in a growth phase or are facing unexpected expenses and need funding fast.
Con #3: More Difficult to Qualify
Qualifying for an SBA loan is often more difficult. The SBA has strict requirements for borrowers, which include having a strong credit score (usually 680+), a solid business plan and a demonstrated ability to repay the loan. Additionally, the SBA often requires collateral for loans, which can be a barrier for small business owners who do not have significant assets to offer.
In contrast, online term loans often involve a less stringent application process, as the underwriting criteria is less complex, the approval process is typically faster and they are not secured by business assets.
The Bottom Line
Ultimately, SBA loans are ideal for franchise businesses that need a versatile funding solution with lower interest rates, longer repayment terms and flexible uses of proceeds to help keep their operations running smoothly. With less paperwork and less risk involved, online term loans can be a more accessible financing option for franchise entrepreneurs who require quick access to capital.
After taking a look at the pros and cons of SBA loans for franchise business funding, be sure to do your research and consult with a highly qualified partners who have your best interest in mind.
