Franchise Financing: How to Fund Your Franchise Purchase

Franchising offers a middle ground between starting from scratch and buying an existing business. You get a proven brand, established systems, and ongoing support. But franchise costs add up quickly: franchise fees, buildout, equipment, working capital, and ongoing royalties.

Understanding franchise financing options and what lenders look for helps you structure a deal that works financially from day one.

Total Franchise Investment

Franchise costs extend well beyond the franchise fee. A complete investment typically includes:

Franchise Financing Options

SBA Loans

SBA loans are the most common financing for franchises, particularly for first-time franchisees:

• SBA 7(a): Up to $5 million for total project cost including working capital
• SBA 504: For real estate or major equipment; 10% down
• Pre-approval: SBA maintains a franchise directory of pre-approved franchises
• Requirements: 680+ credit, 10-20% down, industry or management experience

SBA Franchise Directory advantage: Franchises on the SBA directory have already been reviewed. Unlisted franchises require additional review, adding time to the process.

Franchisor Financing Programs

Many franchisors offer financing assistance to qualified candidates:

• Direct financing: Some franchisors lend directly, often for franchise fee or equipment
• Preferred lender programs: Relationships with lenders who understand the brand
• Equipment leasing: Franchisor-arranged leases for required equipment
• Fee financing: Spread franchise fee over time rather than paying upfront

ROBS (Rollover for Business Startups)

ROBS lets you use retirement funds to invest in your franchise without early withdrawal penalties:

• How it works: Create a C-corp, establish a 401(k), roll over existing retirement funds, invest in your company stock
• Typical amount: $50,000-$300,000
• Advantages: No debt, no monthly payments, tax-advantaged
• Risks: Your retirement is tied to business success; IRS scrutiny if done incorrectly
• Setup cost: $3,000-$7,000 for legal and administration

What Lenders Evaluate

Franchise lenders look at both you and the franchise brand:

• Your credit: 680+ personal FICO typically required
• Your experience: Industry experience or transferable management skills
• Your equity: 10-30% of total investment as down payment
• Brand strength: Franchise history, failure rates, unit economics
• Territory: Location viability, competition, demographics
• FDD financials: Item 19 earnings claims, franchisee validation

Understanding Item 19

Item 19 in the FDD contains financial performance representations. Not all franchisors provide this, but when they do, analyze it carefully:

• What is included: May show average revenue, median revenue, or range
• What is excluded: Often does not show profit, only revenue
• Sample size: Is the data from 10 units or 500?
• Geography: Are these national numbers or specific regions?
• Unit type: Are these corporate units or franchisee-owned?

Cash Flow Projections

Lenders want to see that the franchise can service debt. Build projections showing:

• Revenue ramp: Expect 60-80% of mature revenue in Year 1, increasing to 100%+ by Year 3
• Operating expenses: Rent, labor, COGS, royalties, advertising fund, insurance
• Debt service: Monthly loan payments including principal and interest
• Owner draw: What you need to live on
• Net cash flow: After all the above, is the business profitable?

Rule of thumb: If the franchise cannot cash flow with debt service while paying you a reasonable salary within 18 months, the financing structure may be too aggressive.

Multi-Unit Development

Experienced franchisees often sign multi-unit development agreements:

• What it is: Commitment to open multiple units over a defined period
• Financing implications: Lenders may approve a master facility covering all units
• Lower per-unit costs: Volume discounts on equipment, streamlined operations
• Risk: You commit to opening units whether or not early units succeed

Most lenders prefer to see proven success with 1-2 units before financing aggressive multi-unit expansion.

Common Franchise Financing Mistakes

• Underestimating working capital: Many new franchises fail from undercapitalization, not poor operations
• Ignoring ongoing royalties: 5-8% royalty plus 2-4% advertising fund are ongoing costs
• Using home equity for everything: Putting your house at risk for a franchise is dangerous
• Not validating: Trusting FDD numbers without calling existing franchisees
• Rushing the process: Franchisors have sales quotas; take your time to evaluate properly

The Bottom Line

Franchise financing is well-established, with SBA loans serving as the primary vehicle for most new franchisees. The key is ensuring adequate total capitalization, including working capital, and building realistic projections based on validated data from existing franchisees.

Do not rely solely on what the franchisor tells you. Study the FDD carefully, call existing franchisees, build conservative projections, and make sure the numbers work even if performance is 20% below expectations. A good franchise is a proven system, but it still requires adequate capital and solid execution to succeed.