Cost of Starting a Franchise: The Options and How to Get the Required Finance

what is the cost of starting a franchise

‘What is the cost of starting a franchise?’ Probably the most commonly asked questions by the people who are looking to start a franchise. The answer, however, is not as simple and straightforward as the question.

General Cost Required to Open a Franchise

Note: Though the cost details given below are common for almost all of the franchises, some may have different requirements. As per the Wall Street Journal, the prospective franchisee should be ready to pay about 20% of the total cost of the franchise on his own. However, the said cost varies and depends on the total cost of the particular franchise.

When looking for a franchise, there are thousands of opportunities that you can avail of to get and build a profitable business franchise. All of these have different requirements and where some of them may need a few thousand to start, others may need considerably more to start. According to Michael H. Seid, the industry expert and the founder and managing director of Michael J. Seid & Associates, the franchise fee could be anything up to or over $100,000.

Why is there such a variation in the cost? It depends on the kind of the franchise and the requirements of the franchises and the franchisors. For insurance, some franchises need a dedicated commercial property while others could be started from the home. Some franchises will need special machinery and the place where the franchise is located also plays a big role in determining the price.

To know more, you must check the franchise brand’s franchise disclosure document (FDD) to know about the cost details. In case you have any questions, better to ask the franchisor beforehand.

Having an FDD is important to help you decide and get the required budget for the investment of your franchise. To get the FDD, ask the franchisor to provide you one before you sign the official and legal documents. The FDD must be according to the Federal Trade Commission (FTC) guidelines.

In the document, the initial investment details are given in items 5 and 7. However, there are some costs that are common regardless of the type of franchise. And one such cost is the fee of the franchise.

The franchise fee is the amount you pay to get onto the franchise game. It is the fee that you pay to the franchisor to do the initial work for you and for saving you time and efforts that are required when working on a business from scratch.

Some common opening cost and fees for a franchise are:

  • Office equipment, machinery, and supplies
  • Specialized and modern equipment
  • Construction and lease cost, in case of dedicated commercial property
  • Decor and signage like icons, graphics, symbols, and emblems to represent the brand
  • Inventory, in case of an eCommerce franchise
  • Additional fees for license, accounting, and legal formalities
  • Insurance cost
  • Taxes
  • Advertising and marketing investment

Many potential franchise owners do not know which kind of franchise will be the best and right for them. They often look for help; a complete guide to how to choose the right franchise will help them in deciding about the right kind of franchise.

Finding the Financing Options

financial growth of franchises

Getting Ready to Find the Financial Options

Because most of the people could not finance the entire franchise on their own, they look for other financial options like banks and credit unions. Fortunately, since there is a favorable rise in the franchising landscape, lending has become much easier than it was in the last few years.

how financial background helps with decision of the lender

Before you meet the potential lender, it is important that you prepare all the needed documents beforehand. This will accelerate the whole process and will show the franchisor how responsible you are. Since the lenders are not very keen on taking financial risks, presenting yourself as a trusted soul will definitely work for your benefit.

The very first thing that you will need is your resume. The resume must cover your personal background, academic details, and work history. Additionally, add the proof of your residence, personal financial statements of at least 12 months, bank statements, and tax returns of at least 3 years. If applicable, you can also add the financial details of your previous business ventures also.

When considering an applicant for the loan, the lenders consider the following 5 Cs of Credit:

  1. 1. Capacity: The debt to income ratio
  2. 2. Capital: Additional savings and investments, needed to repay the loan
  3. 3. Collateral: A valuable ownership pledges in case you are unable to repay the loan
  4. 4. Conditions: The usage of the money
  5. 5. Credit History: Prior track record of timely payments

Your financial background will be added and covered in the credit report. Credit reporting companies like TransUnion, Equifax, and Experian help in keeping a track of both the purchase and payment and work and residence history. To get your credit reports, go to AnnualCreditReport.com, and get your report. It is an official government website that provides free annual credit reports.

In some cases, the details may differ from one bureau to another. If you notice any discrepancies then you can have them rectified by contacting the respective bureau through the contact details given on their official sites.

Apart from this, the lenders also use a credit score to determine your suitability and to evaluate your loan application and credit report. The credit bureaus generate the credit score as per the information stored in their database. Credit scores are also known as ‘FICO score’ and this is because they are generated through the Fair Isaac Corporation (FICO) software.

Generally, the score ranges between 300 and 850 and gives the lender an idea of your financial situation. The higher the score, the better. Key elements used to determine the score are:

  • Payment history: 35%.
  • Amounts owed: 30%.
  • Length of credit history: 15%.
  • Credit mix: 10%.
  • New credit: 10%

The percentages that are mentioned above are based on the general population. The significance of the said factors depends on the individual franchisee and his exclusive situation. But all the scores are based on the information that has been derived from the credit report. Besides, you will also have to prepare a business plan when applying for your franchise’s financing.

Parts of a Business Plan: What is Included?

parts of a business plan
  • An Executive Summary: A complete overview of the business plan and the goals of your business. Write this part of the plan after writing the entire document.
  • The Company Description: Describe and explain the franchise that you want to open.
  • Market Analysis: Explain the respective industry and state how your franchise will help in improving it. Mention your competitors and how you fit with them.
  • The Organizational Hierarchy: Are you the sole owner? Will there be other people involved in the management? If yes, explain the organizational structure and add a chart displaying the roles.
  • Description of the Products or Services: What are you going to offer? Explain the products or services in detail.
  • Sales and Marketing Plan: How will you advertise your business? Explain the mediums that you will use to promote your business and sell the services or products.
  • Financial Plan: Here, state the financial needs and projection of your franchise. Explain the cash and revenue inflow for at least one year of the business.
  • Finance Request: State the amount of money that you will need from the lender and the approximate time when you will return the money.
  • Appendix: The appendix is used to explain and add details like the media clippings, resume, and pictures of some ideal sites to encourage the lender.

Having a solid business plan for your franchise is a very important part of the process. However, many new franchisees do not know how to create one. The good news is that with effective franchise business plan writing help, you can write the plan successfully and move forward with your business.

Here, the franchisor could be a great help for you as most of the needed details are present in the FDD. If you are lucky then your franchisor could also help you determine the potential earning rate of the franchise, based on the historical business record.

SBA Loans

When looking for a loan for your franchise, you will come across some franchises that employ that they are SBA approved.

However, this does not mean that you will get the funding automatically from the Small Business Administration (SBA) in case the franchisor accepts your offer. Actually, the SBA does not give the loan itself but it gives a partial guarantee on your behalf to the banks that are involved in their program.

The term ‘SBA Approved’ specifies that the franchisors have done their best to minimize the loan process for the potential franchisees. When giving the loan, the lender evaluates the person they are giving the loan to as well as the franchise system that is involved. It also means that the lender will evaluate both the franchise system and the franchisee.

Franchises that are SBA approved have gone through a formal process with the SBA and had pre-vetted themselves for the loan applications. Due to this, the SBA loan process is simple and the time will also be less than those that do not have SBA approval.

It is somewhat similar to the TSA Pre-Check at the airport and though they still have to go through the security, they will not have to spend much time at the airport. It is the most common form of loan for the franchisees and the General Small Business 7 (a) loan.

Nearly 10% of the SBA loans are given to the franchises and they offer up to $2 million per loan.

Other Franchise Financing Options

Besides SBA, there are other financing options also. Below, we have discussed some real-life examples of different franchises and the way they have used different financing options to finance their franchises.

Franchisor Financing

To know if the franchisor is offering the financing options, check item 10 of the FDD. Though not all of the franchises are offering such a facility, some franchises do offer assistance to ease the lending process.

how to know if franchisor is offering financing options

To know the kind of financing options a franchise is offering, check item 10 of the FDD. Here, you will know whether the franchisor is guaranteeing the loan or taking partial responsibility for the repayment of the loan, in case the franchisee is unable to pay the loan on his own.

Franchisor Financing: A Case Study

Remi Tessier wanted to get financing for a Marco’s Pizza franchise in Warner Robins, Georgia, and based on his impeccable credit and businessman track record, he was sure about getting the financing without much hassle.

However, he did not like the terms and conditions of different banks and turned to his franchisor for help. Through Marco’s Pizza’s leasing program, he secured $250,000 as of the initial opening cost of the franchise.

Family or Friends Financing

how to handle financing from friends or family

Other than banks and credit union bodies, friends and family are the two other kinds of financing options. One way of doing it is when the family member or the friend joins as the business partner and shares the financing load as well as the profit.

The other way is when one of the family members or a friend lends the money, which the franchisee pays back at the agreed-upon time.

Before you accept the money or another person as the business partner, create an official and legal agreement with all the terms and conditions laid out in it. Consult a professional lawyer to do all the legal work for you.

These agreements should be the same as you would have with any other business partner. The main goal of these agreements is to keep both parties informed about the terms and conditions of the agreement and to avoid any future issues.

Family and Friends Financing: A Case Study

After moving to the United States, Sandip Patel thought of getting a Dunkin’ Donuts franchise but he lacked the required money. While he was checking his options, one of his cousins, also a Dunkin’ Donuts franchise owner, agreed to lend him an initial investment of $120,000.

Sandip paid a lump sum amount to his cousin each month and with his family’s support, he succeeded in opening four Dunkin’ Donuts and four Taco Bell franchises.

Sandip recommends the budding franchisees to be careful when accepting the money from a family member or a friend and keep all the documents and legalities intact.

Online Funding Marketplaces

online funding for prospective franchisees

With everything, the lending process has also gone digital. Now, the prospective franchisees could connect with the lenders online and get the required financing. One of these online lending marketplaces is Boefly.

To get started, create the account and make a loan request through it. Boefly will connect you with the ideal and compatible lenders. The database has over 5,000 banks and lenders that are connected with potential franchisees. Some of the names that have used Boefly are Great Clips, Pizza Hut, Subway, Toppers Pizza, and more.

Another finding marketplace is Biz2Credit that helps new and potential franchisees in getting the needed funding. As per the company, they can help with arranging SBA loans, bank loans, equipment funding, commercial real estate funding, refinancing and business acquisition loans. Moreover, they have special and dedicated lending programs for women, minorities, and veterans.

FranFund is yet another online funding company that helps entrepreneurs get the funding they need. They connect the people with financial consultants that guide them through the funding process and help them choose the right funding option.

Online Funding Marketplace: A Case Study

Founders of the packaging company, Les and Claudia Davis planned to expand their business profile by acquiring the TCBY frozen yogurt franchise. They were already experienced with the funding process and want to make the process as hassle-free as possible.

They contacted the TCBY franchiser and they suggested they get the required funding through Boefly. They created the account and after creating their fund request, they received several responses from the potential lenders. After evaluating the requests, they chose a bank that suited their needs.

Financing from Your Retirement Account

financing from your retirement account

Unlike other methods, this one is rather risky and you will have to be extra diligent when working through this method. However, this does not mean that you cannot succeed with this method. But you will have to do a little planning to do it.

Instead of withdrawing the money directly from your 401k or IRA and pay the additional taxes you can set up and display C corporation to be the owner of the business. Afterward, you can transfer the money into the corporation’s profit-sharing or stock program. From there, you can use the money to invest in your franchise.

Because the risk factor is very high in this investment option, you will have to be really careful when taking the money out of your retirement fund. When working on this option, it is important that you work with an accountant to make sure that you do not end up in any trouble. For this, BeneTrends Financial is a good company that helps prospective entrepreneurs and franchisees to use their retirement money wisely.

Retirement Account Financing: A Case Study

Glenn Burell, a prospective franchisee, and a retiree from the finance industry wanted to change his career and owning a franchise looks like a perfect opportunity. He researched several businesses and industries, he chose a CMIIT franchise that would offer information technology consultation and computer support services.

After that, Glenn started his search to secure funds for his franchise. He considered and evaluated both FranFund and BeneTrends and went with FranFund to help him invest his 401(K) fund for his franchise.

According to him, his decision to use his retirement funds was wiser than getting financing from a bank or any other method since he does not have to worry about the interest and repayment. The entire process took him about four to six weeks and he advises everyone looking to invest their retirement funds to be careful when taking any decision.

However, there are a number of small business loans and grants that help small businesses and for more coverage, check SBA guaranteed loans and work on your dream of becoming a franchise owner.

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