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One of the main concerns many franchisees have is coming up with the startup costs necessary to buy and open their first franchise location. Many are surprised to learn that right now there is a lot of money out there to be had, and one of the best sources for it is through the U.S. Small Business Administration (SBA).
In 2021, 14% of all SBA 7(a) loans went to franchisees, representing nearly $4 billion.
One distinction of an SBA loan is that the SBA doesn’t issue the loan directly. Instead, it offers guaranteed payment security for the issuing bank. The SBA has relationships with banks in all states. Banks like working with the SBA because it offers them a virtually no-risk lending situation. The bank can profit more from the loan by selling the guaranteed portion of the loan at a premium in the secondary market, as well as from interest income and from a monthly fee for servicing the loan. It’s easy to see why lenders love the SBA program.
SBA loans are a popular source of funding for franchisees because the loan term is usually longer than a conventional loan and because the SBA guarantees a part of the loan for the bank. Different banks offer different options with SBA loans. For example, some may offer a fixed interest rate for the length of the term, an attractive option in our current economy with interest rates on the rise. Banks that are preferred lenders with the SBA can make final credit decisions on SBA loans without submitting them to the SBA for approval, making the process quicker. Smart franchisees will shop around and find the best bank to work with in conjunction with an SBA loan.
Types of traditional SBA loans
The SBA offers two loan programs for franchisees. The SBA 7(a) loan is the ideal option for a general business startup. It’s the most popular SBA program, and in fiscal year 2021, almost 52,000 of these types of loans were granted. The loan can be used for startup expenses, working capital, buying equipment, purchasing real estate or refinancing debt. It can’t be used for ongoing franchise or royalty fees. The maximum loan amount is $5 million. The loan term is 10 years for working capital and 25 years for fixed assets, with no prepayment penalties. While 7(a) loans offer lower down payments and longer terms, they can be more expensive upfront due to SBA fees and the fact that SBA loans are subject to an All Business Assets lien. This means that everything your business owns is collateral for the loan.
The average processing for a loan that includes construction is 60 to 120 days, and if no construction is involved, it can be 45 to 90 days.
The other type of loan available through the SBA is a 504 loan. This loan is designed to purchase major assets like real estate, equipment or aid in facility renovation. The loan amount is usually $5 million or less. A 504 loan offers low money down, usually 10%, and long-term fixed rates. Loan terms range from 10 to 25 years.
SBA fast-track loans
One of the gripes about SBA loans has traditionally been the loan process itself. The SBA Express loan is the solution. While the loan is similar to the SBA 7 (a) loan, the major difference is the funding amount. Instead of $5 million, the SBA Express loan caps at $500,000. However, applicants will get a decision within 36 hours, and for loans up to $25,000, no collateral may be required.
The SBA uses its SBA Franchise Directory to allow franchisees to easily look up if the franchise they wish to purchase is eligible for an SBA loan.
To determine if they wish to fund an SBA loan, banks will assess a prospect application with an eye toward liquidity, operating costs, working capital levels and projected revenue.
According to Rookey, SBA loans can also be a great financing strategy for multi-unit operators. A franchisee can secure an SBA loan for the first unit, a ROBS (rollover for business startup) for the second location so they can open it debt free, and then another SBA or conventional loan for the third location.
When I first started franchising, I used an SBA loan. I put down roughly 1/3 of the project cost and got 2/3 of the costs covered by the loan, making my cash go further. It was the perfect solution, and I always recommend this option to our franchisees.
For new entrepreneurs, those new to franchising and even multi-unit operators, an SBA loan can be the best path to securing capital.