What Should Borrowers Know About Franchises and the SBA 504 Loan?

A franchise is a business model where one business owner, known as the “franchisor” sells the rights to their business. Rights include business logo, name, model as an independent “franchisee”, and sometimes a territory all your own.

The most popular form of franchising is known as Business Format Franchising. Typically, as the franchisee, you have an ongoing relationship with the franchisor, who provides a “turnkey” business management plan: training: both on management and day to day employees, marketing plans, and site selection. Hotels, Service based businesses, and restaurants are commonly franchised.

Remember when buying a franchise while you get the benefits of the rights and brand recognition, you must adhere to rules from the franchisor to run your business- I’ll touch on this in the last section.

Buying an existing business gives you all the control, however, offers less guidance. While the hope is many of the key employees will stay, it is never guaranteed. This can greatly impact your results as a new owner. Therefore, it is always recommended you have strong industry experience in the business you are looking to purchase.

Steps to secure Franchise financing:

Identify an industry and be honest about your skills, experience, and personal financials.

• Collect the Franchise Disclosure Document (FDD)?Prior to signing?any Letter of Intent or Franchise Agreement. This document is the road map to understanding exactly what rules, agreements, and fees will be required of you. It also lets you know how the franchise is doing financially and how many units they have to date, and how many they plan to develop.
• How much are you willing to come out of pocket? Keep in mind that franchise fees are a part of the agreement and can be quite costly depending on the brand. The franchise fee goes to the franchisor for the rights.
• How much liquidity do you have after all costs (franchise fee, attorney fees, etc.)? Some franchises and banks require you to have a certain amount of liquidity pre-funding of a SBA loan. This is also after the required down payment specific to the bank you are looking to secure a loan. (10%-30% of total project)
• Application Process: Gather all required financial documents personally as all SBA programs require a?personal guaranty of anyone holding 20% or more ownership.
• Prior?to signing any Franchise Agreement, review with not only your attorney, but also the lender.
• The 504 Program provides lower down payments and longer terms than most conventional loans, for the financing of Commercial Real Estate & Equipment. Often times a 504 loan for the real estate and equipment and 7a loan for the acquisition or start-up costs can be utilized as companion loans when starting a new or purchasing an existing Franchise opportunity to help you save available cash that can be used for the working capital needs of the new business.

What to be on the lookout for?

I cannot stress this enough: before signing any Franchise Agreement and prior to putting any money down to secure rights, please consult an attorney and the lender you are working with to determine?your rights. As a Franchisee, you need to meet certain sales quotas, keep a certain amount of inventory, and meet a performance score. You will also need to understand up front, when you sign up for a specific territory you may be?required?to open several stores within a certain timeframe, and the financial obligation as well as the ability to continue to secure proper capital financing should be kept in mind. This can present some challenges if store #2, #3 & #4 will need to be open consecutively and within a short time frame. These considerations include down payment requirements, liquidity, and cash flow to cover the existing and proposed obligations on the first location before you can continue opening the next location.?Many times, you can work with attorneys to amend aggressive territory requirements and location obligations.

To be noted:

• Is the franchise determined as an “Emerging Franchise”? An Emerging Franchise is a newer venture that has 50 units or less. They may have all the plans to be great and develop rapidly, but many times franchises considered “emerging” cannot secure financing outside of their own personal investment. This is because the franchise isn’t considered proven. The franchise will not have the balance sheet or proven profit/loss statement to support considerable growth and default scenarios.
• With access to several lender or broker private franchise search platforms you will want to know the ratio of underperforming or defaulted units the franchisor has prior to investing.
• On May 11th, 2023 new SBA rules will be put in place to eliminate the Franchise Directory and affiliation will no longer be established through franchise/license agreements affiliation will now be based on ownership and like industry codes.

To ensure borrowers receive all the benefits of the SBA 504 Loan Program, contact an FCF/FFC?Business Development Officer?early in the process.?We are here to help!

With 40 years’ experience, FCF/FFC is one of the nation’s top-ranked CDCs serving Florida, Georgia, and Alabama. To learn more about the SBA 504 Loan Program,?click here.