If you’re looking into franchise ownership, it’s likely that one of the top questions you have pertains to financing. After all, you can’t own a business if you don’t have the necessary funds to start it. While there are various financing options available, a common way to obtain a loan is through the U.S. Small Business Administration (SBA).
Funding a franchise is no small feat and typically requires some level of financing. Amanda Berry, a franchise consultant for FranNet, offers helpful information regarding this process.
If you’ve started the process of researching which franchise might be the best fit, you’ve probably seen that some use the term “SBA-approved”. Understanding what this means is key to evaluating your financing options for buying a franchise.
What Does SBA Stand For?
SBA stands for the U.S. Small Business Administration, a federal agency that supports small businesses through programs that provide access to capital, counseling, contracting opportunities, and other resources.
When people talk about an SBA loan for a franchise, they are generally referring to a loan made by a participating lender that receives a guarantee from the SBA, rather than a loan made directly by the federal government.
The SBA guarantee can reduce a lender’s risk, which can make SBA-backed financing an option for eligible small businesses that may not qualify for conventional financing on comparable terms.
However, an SBA guarantee does not mean every franchise buyer automatically qualifies. Borrowers must meet applicable SBA and lender requirements, including requirements related to creditworthiness and the ability to repay the loan.
What Is an SBA Loan?
Technically, the U.S. Small Business Administration does not directly extend loans for financing a small business, rather it provides the backing that a small business needs to acquire the loan from a private lender. There are a couple types of SBA loans available for those who are planning to buy a franchise.
SBA 7(a) Loan Program
The SBA’s 7(a) program is the SBA’s primary business loan program. It can be used for purposes including working capital, equipment, furniture and supplies, real estate, and changes of business ownership. The maximum 7(a) loan amount is currently $5 million.
The SBA’s website specifically states that these loans can be used for:
- Long- and short-term working capital
- Revolving funds based on the value of existing inventory and receivables
- The purchase of equipment, machinery, furniture, fixtures, supplies, or materials
- The purchase of real estate, including land and buildings
- The construction of a new building or renovation of an existing building
- Establishing a new business or assisting in the acquisition, operation, or expansion of an existing business
- Refinancing existing business debt, under certain conditions
There is an extensive checklist for those applying for a 7(a) loan so you should seek guidance from an experienced CPA or another franchisee that has gone through the process already.
Visit 7(a) loans on the SBA’s website for more information.
504/CDC Loan Program
Franchisees can also apply for a 504/CDC loan, which “provides long-term, fixed-rate financing for major fixed assets that promote business growth and job creation.” For most 504 loans, the maximum amount offered is $5 million, but for certain energy projects “the borrower can receive a 504 loan for up to $5.5 million per project, for up to three projects not to exceed $16.5 million total.”
Since the purpose of a 504 loan is to promote business growth and job creation, the SBA outlines the specific requirements for how a business owner can use the loan.
These include the purchase or construction of:
- Existing buildings or land
- New facilities
- Long-term machinery and equipment
Or the improvement or modernization of:
- Land, streets, utilities, parking lots, and landscaping
- Existing facilities
A 504 loan cannot be used for:
- Working capital or inventory
- Consolidating, repaying or refinancing debt
- Speculation or investment in rental real estate
It’s important to note that a 504 loan is only available through a Certified Development Company (CDC).
Visit 504 loans on the SBA’s website for additional information.
Why Is It So Desirable?
It can be difficult for a small business to qualify for a conventional business loan, but a lender’s standards are less stringent for a loan that is guaranteed by the federal government. According to the SBA, it “helps small businesses get funding by setting guidelines for loans and reducing lender risk. These SBA-backed loans make it easier for small businesses to get the funding they need.” The SBA guarantee can reduce the lender’s risk, which can make SBA-backed financing available to eligible small businesses that may not qualify for conventional financing on comparable terms.
Additional Reading: How to Start a Franchise With No Money – Is It Even Possible?
How Can You Use SBA Financing to Buy a Franchise?
If you’re considering an SBA loan for a franchise, start by determining how much capital you’ll need and what expenses the financing will cover.
Depending on the SBA program and loan structure, financing may be used for expenses such as:
- Franchise startup costs
- Working capital
- Equipment and machinery
- Furniture, fixtures, and supplies
- Real estate
- Construction or improvements
- Changes in business ownership
- Certain business debt refinancing
The SBA’s 7(a) program is particularly relevant to franchise buyers because it allows eligible borrowers to use loan proceeds for several purposes, including working capital and changes of ownership.
From there, you’ll work with a participating lender to determine your eligibility, loan amount, required equity contribution, repayment terms, and other conditions.
Because lender requirements can vary, prospective franchisees should compare financing options and work with qualified financial professionals when determining how much they can reasonably borrow.
What Does “SBA-Approved” Mean for a Franchise?
You may see franchise brands described as “SBA-approved” franchises when researching business opportunities. However, this terminology can be misleading.
The SBA maintains a Franchise Directory that lenders and Certified Development Companies (CDCs) can use to evaluate whether a franchise or other brand is eligible for SBA financial assistance. The SBA states that the directory contains franchises and other brands that have been reviewed and found eligible under its requirements.
Importantly, being listed in the SBA Franchise Directory does not mean the SBA has endorsed or recommended the franchise. The SBA specifically states that placement in the directory is not an endorsement or approval of the brand and does not guarantee the success of the business.
It also does not mean that every prospective franchisee will automatically receive an SBA loan.
Your individual application still needs to meet the applicable requirements of the SBA loan program and the participating lender. Lenders evaluate factors such as the borrower’s creditworthiness, ability to repay, business purpose, and other eligibility criteria.
For this reason, it is more accurate to think of an SBA-eligible franchise as a franchise whose business model and documentation meet the applicable requirements for SBA financing, not a franchise that has received a blanket guarantee of financing.
Does an SBA-Approved Franchise Guarantee You’ll Get a Loan?
No. A franchise’s eligibility for SBA financing does not guarantee that an individual franchisee will receive an SBA-backed loan.
There are two separate considerations:
#1 – Franchise Eligibility
The franchise or brand must meet the applicable requirements to be eligible for SBA financial assistance and, where applicable, appear in the SBA Franchise Directory.
#2 – Borrower and loan eligibility
The individual applicant and proposed loan must also satisfy the requirements of the applicable SBA program and participating lender.
Prospective franchisees should evaluate both the franchise opportunity and their own financing qualifications before assuming an SBA franchise loan will be available.
SBA Franchise Directory vs. Franchise Registry
If you’re researching SBA franchise loans, you may encounter two different resources: the SBA Franchise Directory and the Franchise Registry maintained by FRANdata.
They serve different purposes.
What Is the SBA Franchise Directory?
The SBA Franchise Directory is maintained by the U.S. Small Business Administration and is used by lenders and Certified Development Companies to evaluate the eligibility of businesses operating under franchise agreements. The directory includes franchises and other brands that the SBA has reviewed and found eligible for SBA financial assistance.
However, directory placement is not an endorsement of the franchise, and it does not guarantee that a particular franchisee will qualify for financing or that the business will succeed.
What Is the Franchise Registry?
The Franchise Registry is a separate industry resource maintained by FRANdata. It provides information and documentation about franchise systems to lenders and other parties involved in franchise financing.
The two resources should not be treated as interchangeable. The SBA Franchise Directory addresses SBA eligibility, while the Franchise Registry is an industry resource that can help lenders evaluate franchise systems and access relevant information.
What Happens If You Default on an SBA Loan?
Defaulting on an SBA-backed loan can have serious financial consequences, just like defaulting on other business financing. Although the SBA guarantees a portion of the loan for the lender, that guarantee does not eliminate the borrower’s responsibility to repay the debt.
If a borrower stops making payments and the loan goes into default, the lender will generally begin its servicing and recovery procedures. Depending on the circumstances, this can include working with the borrower on a solution, pursuing available collateral, and taking other collection or liquidation actions.
Does the SBA Pay the Loan If You Default?
Not automatically. An SBA guarantee protects the lender against a portion of its potential loss if a qualifying loan defaults. In some circumstances, the lender can ask the SBA to purchase the guaranteed portion of the loan after the required servicing and liquidation steps have been followed.
What Can Happen After an SBA Loan Default?
The consequences depend on the loan, the borrower’s circumstances, the collateral involved, and the terms of the loan documents. Potential consequences can include:
- Collection efforts: The lender may pursue repayment of the outstanding balance.
- Collateral liquidation: If the loan is secured, the lender may be required to pursue the collateral as part of the recovery process.
- Credit consequences: A default can negatively affect the borrower’s credit history.
- Legal action: Depending on the circumstances, the lender may pursue legal remedies to collect the debt.
- Continued liability: An SBA guarantee does not necessarily eliminate the borrower’s obligation for any remaining debt.
What Should You Do If You Are Having Trouble Making SBA Loan Payments?
If you anticipate difficulty making payments on an SBA-backed loan, contact your lender as soon as possible rather than waiting for the loan to default. Depending on the circumstances, the lender may be able to consider servicing or workout options.
For franchise owners, understanding the potential risks and repayment obligations before taking on SBA franchise financing can help you make informed decisions about the amount of debt your business can reasonably support.
Ready to Start Financing?
Figuring out financing is a lot of work and can be difficult to navigate. However, that doesn’t need to stop you from pursuing franchise ownership. A FranNet franchise consultant will guide you every step of the way – from choosing the right franchise, understanding your different funding options, to actually becoming a franchise owner. Even better, they will do this at no cost to you! Contact a FranNet representative to schedule your free consultation today!