If you are going to buy a franchise you are most likely going to need to borrow money. You will want to clean up your finances before applying for a loan because being turned down for credit can make future loans more difficult to obtain.
Of course borrowing money means that you need a good credit score. Ideally, you want a credit score in the 700s since 800 is the top score. Clean up any errors on your credit report from the three top credit rating agencies – Experian, Equifax and TransUnion. They may differ in what they show so check with all three.
Because you are going to be assuming more credit, you should try to pay off any balances on credit cards and consumer loans. If you can lower your personal finance costs by refinancing your mortgage, do so. Don’t close credit lines or cancel existing credit cards or other credit arrangements; that will lower your credit score.
You will also need savings. Nearly all franchising companies and banks want you to have some of your own money invested, ranging from 10% to 25%, with 20% probably the most common.
Depending on the franchising company, your loan will either be directly with them or indirectly through an SBA-approved bank. Advantages of going through are that the company may defer a portion of the finance fee and may not require collateral, but their rates are likely to be higher than a bank’s.
If you go through a bank, SBA loans are partially guaranteed by the government making them less risky. But, the health of the franchising company is doing, their length in business and the number of locations will be important to the bank. Your loan will normally be secured with collateral like your home or other assets. Having a relationship with a banker may help to get a loan, as will relevant experience and community involvement. Since many SBA loans have a floating interest rate tied to the prime rate, consider that your monthly payments may increase significantly if interest rates rise.
In either case, you will need to present a personal financial statement, copies of your last three years of tax returns and verification of the source of your down payment. It should not be borrowed.
Finally, you may want to get a line of credit in addition to the loan financing the franchise fee and other start up costs. A line of credit will help you when your cash flow is uneven which it is likely to be, especially early in your franchise’s life and maybe longer if the franchise has any seasonality. Many businesses do and that is a surprise to many owners. For example, December and January are often slow months. Pay your credit line down to zero at least once a year.
Be honest and conservative with what you can afford. Try not to tap your retirement savings. Give yourself a credit line to help with cash flow unevenness, and most importantly, if you are married, make sure you are both in agreement. Consider using the services of a franchise consultant, they can point you in the right direction. Then put your heart into your business.
