Many small business owners struggle to receive traditional loans at affordable rates. Small businesses simply don’t have established creditworthiness, making it risky for lenders to provide them loans.
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.
- SBA loans can be used toward a new or existing franchise.
- The 7(a) loan program offers funds for a variety of franchise uses, including capital for day-to-day expenses, initial franchise fees, and major purchases.
- The 504/CDC loan program can provide funds for a new franchisee to buy land or long-term equipment.
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.
You can use an SBA loan to open a franchise, however, you must meet certain requirements to receive the funding. First, the franchise must be listed in the SBA franchise directory for a franchisee to be considered for a loan.
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 location
- Buying an established franchise from a prior franchisee
- Scaling 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.
|7(a) Loans||504/CDC Loans|
|Franchise Uses||Establishing and operating the business as well as real estate or heavy equipment||Purchase of real estate and large equipment or machinery|
|Eligibility||Be a small business, operating as a for-profit in the U.S., have invested equity, demonstrate good credit history||Operating as a for-profit in the U.S., have a net worth of less than $15 million, have a net income of less than $5 million|
|Lenders||Most SBA lending partners||Certified Development Companies (CDCs), promoting economic development in communities|
|Guarantee Percentages||85% for loans up to $150,000 and 75% for loans above $150,000||100% of CDC’s portion (usually 40% of the total loan)|
|Loan Amounts||Maximum $5 million||Maximum $5 million|
|Maturity Terms||10 years for equipment or working capital and up to 25 years for real estate||10- and 20-year terms|
SBA 7(a) Loan
The 7(a) loan program is a popular SBA loan because it allows for a wide variety of uses for the funds. Business owners can, for example, increase working capital, purchase equipment or land, construct new buildings, and outfit offices. With franchises, this loan type can cover initial franchise fees but not those associated with franchise development.
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.
Interest rates for these loans are set by the lender, but the SBA does set maximums allowed. These range from a base rate plus 2.25% to 4.75%, depending on maturity and loan size. Fees also range from 2% to 3.5% based on loan size.
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.
A 504 loan can provide money to purchase a property, but it can’t provide an injection of working capital to run the business like a 7(a) loan can.
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:
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.
Frequently Asked Questions (FAQs)
How do you register a franchise with the SBA?
You may want to open a franchise that isn’t on the SBA franchise directory. In this case, you can submit a brand for review by providing franchise documentation, a disclosure form, and other relevant material required by the SBA. You should also include the franchisor's contact information.
How hard is it to get an SBA franchise loan?
SBA loans are intended to be more accessible to small businesses than traditional loans. The process to receive an SBA franchise loan is similar to applying for a traditional business loan. You’ll be approved based on a number of factors, including the size of your business as well as the brand of the franchise, among others.
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Small Business Administration. “Quick Reference to SBA Loan Guarantee Programs.”
American Bar Association. “SBA Lending; Considerations for Franchisors and Franchisees.”
Small Business Administration. “CDC/504 Loan Program Fact Sheet.”
Small Business Administration. “Terms, Conditions, and Eligibility.”
Small Business Administration. “504 Loans.”
Small Business Administration. “7(a) Loans.”
Small Business Administration. “SBA Franchise Directory.”