The Small Business Administration (SBA) makes funding sources more accessible to small businesses by providing guarantees of 75% to 85% to lenders in case of default. It also sets strict rules around loan terms to make it a cost-effective option for small businesses, including franchise owners. To be eligible, you need to meet several requirements, including using the funds according to the specific SBA loan type. For example, you can use the money to open a franchise or fund an existing one. Let’s learn how two SBA loan programs can potentially provide the capital you need for franchises.
Can You Use an SBA Loan for a Franchise?
A franchise allows you to have your own business while benefiting from the structure and guidance of a larger corporation. Depending on your experience and financial situation, owning a franchise may be an ideal investment for you. SBA loans are designed for small, independent businesses. Even franchisees need to qualify as small businesses to receive funding. The franchise must be either independent, or its affiliations will be considered as well when the SBA takes into account factors like revenue, number of employees, net worth, and income. Finally, both franchisee (the small business owner) and franchisor (established business) will be reviewed in the diligence process. Lenders will look at factors like whether the franchisor’s experience in the industry, the geographic scope of the business, brand establishment, and financial strength, among others. SBA loans can be used for:
Opening a franchise in a new locationBuying an established franchise from a prior franchiseeScaling franchises
SBA Loan Options for Franchises
The SBA offers two main loan options you can use for franchise opportunities: the 7(a) loan program and the 504 loan program. The 7(a) loan program is popular with business owners as it offers up to $5 million to cover expenses such as working capital, refinanced debt, and supply purchases. The 504 loan program covers major fixed assets like purchases of land, equipment, and real estate through long-term, fixed-rate funding of up to $5 million. You can receive up to the maximum of $5 million in funding with a 7(a) loan and the guarantee and repayment depend on the funded amount. The SBA guarantees up to 85% on loans of $150,000 or under and up to 75% of larger loans. Repayment on loans for real estate and major fixed assets can extend up to 25 years, while working capital extends up to 10.
SBA 504/CDC Loan
The 504/CDC loan program is similar to the 7(a) in terms of eligibility and maximum loan amounts, but these loans tend to be for bigger real estate projects. 504 loans are made through Certified Development Companies (CDCs), as an underlying goal of this program is to promote economic development in communities. Business owners can receive up to $5 million to buy real estate, finance construction, or purchase long-term equipment, which are common expenses for opening a new franchisee. The usual structure of a 504 loan includes:
50% of project costs are covered by the lender (non-guaranteed)40% of project costs are covered by the CDC (100% guaranteed by SBA)10% of the project cost from the borrower
Maturity rates on these loans range from 10 years for machinery and equipment and up to 20 years for real estate. This loan also comes with a 3% fee that can be financed with a loan and fixed interest rates.
Which Option Is Right for Your Franchise?
Both the 7(a) and 504 loan programs can help you meet your financing needs for your franchise. The main consideration when deciding between the two is the scale of the project and how you will use the loan funds. Let’s say you are opening a franchise in a new location. Your major expenses may include real estate, construction, and long-term equipment. So, a 504 loan may be a better option because it can cover the property and machinery. If, instead, you intend to use the funds for the daily operations of a franchise or purchasing an already established franchise, a 7(a) loan may be the better option. You can use these funds for almost anything when it comes to working capital, startup costs, inventory, and real estate.
How To Apply for an SBA Franchise Loan
Applying for an SBA franchise loan is similar to a normal loan application. However, you need to be ready to provide your documentation to both the lender and the franchise. Here are the main steps in the application process.
Gather Your Documentation
The first part of any loan application is gathering the necessary documents. The more prepared you can be in this initial step, the smoother your process will be. Use the 7(a) checklist and the 504 Authorization File Library to identify what paperwork is needed. This includes forms like business financial statements, personal income tax returns, and resumes.
Gather the Franchise’s Documentation
The next important step is gathering documents focused on the franchise. You’ll want to ensure you have the proper paperwork from the franchise ready for the lender. This could include franchise licensing agreements, profit and loss statements, and asking price.
Identify Your Local Lender
Once you’ve organized the documentation, you’ll need to find a lender or Certified Development Company to submit your application. The SBA provides an online local assistance tool that identifies certified agencies near you.
Submit and Prepare for Questions
The final step is the application itself. You should be well prepared if you’ve spent the time gathering the necessary information. However, you may need to be prepared for additional questions based on lender needs. The lender will then submit your paperwork to the SBA as required.
Franchise Loan Alternatives
If an SBA franchise loan isn’t right for you, consider these alternatives:
Franchisor Loans
Some franchisors offer financial support to franchisees to get the business operating. This support could include specific loan options, royalty reductions to offset costs, and secured loans through partner lenders.
Traditional Bank Loans
A traditional bank loan can an option for businesses with stronger creditworthiness or a longstanding relationship with a bank. However, traditional loans tend to have less favorable terms than an SBA loan.
Other Business Loans
Other loan options include a short-term loan or equipment loan. Alternative lenders offer smaller loans on a shorter repayment period with a quick application process, while equipment loans through banks or alt lenders cover just the purchase of machinery.
The Bottom Line
SBA loan programs can be a good option if you need funding to open and operate a franchise business. Both 7(a) loans and 504/CDC loans can provide the funding to purchase needed materials and real estate or increase working capital to use on an SBA-approved franchise. Depending on your needs, timeline, and franchise, you may want to pursue other funding options such as traditional loans. No matter which funding option you choose, keep your documents organized and consider consulting a financial advisor for more specific guidance for your situation. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!
