Becoming a franchise owner is a popular choice for many aspiring entrepreneurs. This approach offers a proven business model and brand recognition, giving franchisees a strong foundation to launch off of and expand. However, growth demands capital, and it might be more than what you have in the bank. Fortunately, SBA franchise financing can provide funds for initial costs, monthly rent, equipment purchases, staff hiring, marketing, and more. We went over the SBA and various SBA loans in a previous article here.
When seeking financing, it’s important to understand what lenders look for to boost your approval odds. In today’s article, we will be exploring 5 of the most influential factors affecting your eligibility for SBA franchise financing.
1. Business Finances and Credit History (2 year history)
- Annual Statements: Whether it’s revenue figures, income tax, or profit and loss statements, lenders look for a consistent and profitable business performance. These documents narrate the financial health of your franchise.
- Cash Flow: A positive cash flow indicates your franchise’s capability to sustain operations and manage financial obligations. Lenders will scrutinize cash inflows against outflows to gauge potential risks.
- Balance Sheet: A snapshot of what your franchise owns (assets) and owes (liabilities), this document gives lenders insights into your company’s equity position. A strong balance of assets over liabilities is always a positive indicator.
- Debt Service Coverage Ratio: Simply put, this ratio measures your franchise’s ability to cover its debt with its income. A ratio of 1.25 or higher is typically required by lenders.
- Credit Score: Your business credit score is a testament to its financial responsibility. A score of 160 or above is usually favored by lenders, with 180 being an excellent benchmark. Utilize credit reports from business credit bureaus such as Dun & Bradstreet, Experian, and Equifax.
2. Personal Finances and Credit History
- Net Worth: A high personal net worth can be indicative of sound financial management. Lenders assess your assets (like stocks and real estate) and subtract liabilities (such as mortgages and debts) to gauge your personal financial health.
- Tax and Expenses: Beyond business, lenders examine your tax returns and personal expenses.
- Credit Overview: A high credit score and a clean credit history that is free of red flags such as defaults, foreclosures, tax liens, or court judgments suggest financial reliability.
3. Business Experience
Past performance often predicts future results. Lenders are more confident in borrowers with a proven track record of managing and scaling successful businesses. Typically, a history of at least two years of business operation is seen as an assurance against potential risks.
If you don’t have two years of business history, lenders will want to see if you have any relevant experience or background in the industry. And if you’re new to the industry completely, but still dream of partnering with a franchise, lenders will want to know if the franchisor you’ve chosen to work with will offer some type of training or operational backing to help support you through your business venture.
4. Business Plan
A detailed business plan speaks volumes about a franchisee’s vision, preparedness, and commitment. Key components include:
- Franchise Overview: What is your franchise about? Lenders want to understand the core of your product or service.
- Market Information: Demonstrating knowledge about your target audience, competitors, and market trends is essential.
- Management and Organization: Highlight the strength and expertise of your team.
- Marketing Strategy: How do you plan to attract and retain customers?
- Financial Projections: Provide realistic and research-backed financial predictions.
For franchisees, leveraging the Franchise Disclosure Document can be immensely beneficial, as it contains valuable information about the franchise’s costs and operations.
5. Franchise Details and Project Team Evaluation
Lenders will also want to know details about the franchisor you’re attaching yourself to. They will typically require the franchise’s scope, schedule, and budget to understand your venture’s scale.
Moreover, the credibility of your project team you chose to work with can influence a lender’s decision. Their past achievements, financial statements, and credit histories play a significant role in determining whether or not you get approved for a loan. Partnering with a reputable and financially stable design and construction team, who has experience opening new franchise locations, suggests a project is in good hands.
Therefore, it’s important to partner with a project management team who know what they’re doing and have the evidence to prove it.
Additional Considerations
Significant elements lenders also look out for are:
Debt-to-Income Ratio
This is a measure that compares your monthly debt obligations to your gross monthly income. It essentially quantifies the percentage of your income that goes into servicing your existing debts.
A high ratio could indicate that you’re stretching your finances thin, which may make additional debt risky.
While lenders may have varying thresholds, a debt-to-income ratio below 40% is commonly seen as favorable. This suggests that the borrower has a cushion of 60% of their income, which can accommodate unforeseen expenses or downturns without jeopardizing their debt repayment.
Down Payment & Collateral
Making a substantial down payment demonstrates your commitment to the franchise venture. It indicates that you have skin in the game, reducing the lender’s risk. The more you invest upfront, the less you need to borrow, which can also translate to lower interest payments in the long run.
As an added insurance, collateral acts as a safety net for lenders. This is a tangible asset (or assets) that a lender can legally seize and sell if the borrower defaults on the loan. By offering collateral, you’re providing the lender with an exit strategy, should things go wrong.
These elements send a powerful message to lenders. They showcase your confidence in the franchise’s success, your financial responsibility, and your commitment to honoring the loan agreement. When lenders see these commitments, their confidence in approving the loan often increases.
Tips to Secure SBA Franchise Financing
- BE PREPARED: We cannot emphasize this enough! To secure an SBA loan, it’s crucial to present a strong business plan that clearly outlines your money-making strategies. Lenders value detail, so you must be able to demonstrate not only your revenue strategy but also a detailed budget indicating how you’ll use the loan funds. Ideally, they would like to see a full lending package put together with a complete scope, schedule, and budget that clearly outlines construction and operational costs. To learn how SCGWest can help you compile a comprehensive lending package, call us today!
- Know the process: The SBA recommends educating yourself on the details of the loan approval process before speaking with a lender. That way, you will appear well-informed during your meeting.
- Have a stake in the business: Another important factor in securing a loan is having your own equity invested in the business. How can a lender trust that you truly believe in the franchise if you are unwilling to invest in it?
- Provide More Collateral: If possible, offer additional assets as collateral. This reduces the risk for the lender and can make your application more appealing.
- Clear Existing Liabilities: Before applying, try to reduce or eliminate any existing debt. This can improve your credit profile and show lenders that you’re capable of managing and repaying your financial obligations.
Conclusion
Securing financing is a critical step in the franchise journey. Being well-prepared, informed, and strategic can pave the way for smooth financial onboarding. For tailored advice and insights on project financing, SCGWest is here to guide you every step of the way. Contact us today for more information!
