Jump to Main Content
USA flagAn Official Website of the United States Government
Financing

Blogs.Financing

Register

Buying a Franchise – How to Determine What it’s Going to Cost You

Comment Count:
3

Comments welcome on this page. See Rules of Conduct.

Buying a Franchise – How to Determine What it’s Going to Cost You

By Caron_Beesley, Contributor
Published: August 27, 2012

Thinking of buying a franchise? Do you understand the franchise business model and have you determined it’s a good fit for you?

Perhaps you’ve also explored potential franchises and think you’ve found a match. But how are you going to finance your venture? What can you afford? How much financing should you seek? Should you even be doing this?

To help you answer these questions, here are tips of the trade from franchising pro and fellow SBA.gov guest blogger, Joel Libava, a.k.a. The Franchise King®.

Should you Be Doing This?

Determining exactly how much money you should invest in your franchise purchase is an important question deserving of an entire chapter in Joel’s book –“Become a Franchise Owner”.

According to Joel, you may be asking yourself if you can afford to invest in a franchise, when you should be asking: “should I be doing this?” The answer to this question lies in your unique financial situation. To help you get a clear picture of your own finances, Joel recommends the following:

  1. Develop a Net-Worth Statement – Make a simple two-column list of your assets and liabilities. Add them up and subtract the latter from the former – this will give you a picture of your net worth.
  2. Talk to an Expert – Joel stresses the importance of consulting a financial advisor. A franchise is a major investment and an advisor can help you build a picture of what you truly can afford – not only in terms of the purchase price, but also how much your down-payment should be. 

So How Much Money should you Personally Invest?

Your time with a financial advisor should give you the answer to this question.  As a guideline, Joel suggests (but steers clear of an all-out recommendation) that franchise buyers should invest no more than 15 percent of their own money in a start-up franchise. Say, for example, your net worth is $400,000, of which $80,000 is liquid. The most you would want to invest in a franchise is 15 percent of your net worth, or $60,000.

Investing 15 percent isn’t a hard and fast rule. As Joel’s admits, this number is based on his own risk tolerance and vast experience.  So it’s important to talk to a financial advisor to work out exactly what this percentage should be for you.

What Can you Afford to Buy and What do You need to Borrow?

Once you’ve determined what you can afford to contribute towards a franchise purchase, what kind of dollar range should you be looking at in terms of total franchise investment? In other words, what can you afford to buy and how much do you need to borrow?

Most lenders, Joel explains, want to see franchise buyers come up with 20-25 percent of the total investment in the franchise they’re trying to buy.  Based on Joel’s math from above, $60,000 is 25 percent of $240,000. This means you shouldn’t look at franchises requiring a total investment greater than $240,000.  

OK, so you’re investing $60,000 of your $80,000 in liquid cash in the franchise venture.  Where do the remaining funds come from? This is where borrowing comes into play, either a small business loan or borrowing money from family or friends. Whichever route you choose, you still have $20,000 in your pocket you can save for a rainy day.

Stick to Your Budget

Now that you have a clear picture of what you can afford and your target investment range, be sure to stick to your budget. And, of course, have enough funds set aside to pay your own personal monthly bills. As Joel points out in his book, you’re not going to make money at first – so be prepared. Breaking even comes first, then profits, and only then can you pay yourself a salary (read more about in this blog: 5 Tips for Setting Your Salary as Business Owner).

Financing Options for Purchasing a Franchise

Many banks and credit unions offer financing for franchise purchases.  In fact, SBA data (PDF) shows start-up franchis­es are more likely than other businesses to use a commercial bank loan as their source of funding. 

When you approach a bank, be prepared to disclose all your financial information. While your credit rating is important, you’ll also need to provide a personal financial statement, copies of tax returns, and information about the source of your down payment funds.

You should also be aware that your choice of franchise will have an influence on a bank’s decision to fund you. Franchises with strong brand names, a track record of consistent profits and cash flow, plus an ability to perform well across a variety of diverse locations are going to stand you in good stead when you meet with your bank manager.

If your bank is hesitant about a particular franchise system’s performance, or your finances aren’t as strong as they could be, you might want to consider an SBA loan.  SBA doesn’t lend to business owners directly; it provides a repayment guaranty to banks and lenders for money they lend to small businesses, making it less risky for the banks. Use this search tool to find the right SBA loan for you.

Related Resources

 

About the Author:

Caron Beesley

Contributor

Caron Beesley is a small business owner, a writer, and marketing communications consultant. Caron works with the SBA.gov team to promote essential government resources that help entrepreneurs and small business owners start-up, grow and succeed. Follow Caron on Twitter: @caronbeesley

Comments:

Many franchise owners have tapped their 401k, IRA or other retirement account for franchise financing without paying taxes or penalties. While one should certainly work with an experienced professional, access to these funds can reduce or even eliminate cost associated with debt financing (e.g., interest).
Nice article, Caron. You provided the best in's and out's of financing a franchise. I've heard fo one other option for financing (though I'm not sure how common it is) - financing directly from the franchisor. This seems like it could be a fairly safe option because the franchisor knows how to run the business and is able to help the franchisee be successful. Do you know how common this option is? Also, regarding SBA loans, you can find approved lenders for franchise loans with this tool from Lendio. One of the hardest parts of getting a loan isn't actually the choice of loan - it's the bank process. Banks turn down a lot of borrowers not because they don't qualify, but simply because the bank's specific criteria isn't met. Usually, it's just about finding the right bank. With Lendio, the bank actually comes searching for you. This makes everything so much easier. (This comment was edited to remove a link. Please review our Community Best Practices for more information about how best to participate in our online discussions. Thank you.)
I like the stick to your budget part. Too many times people rush into these things and end up regretting it later. Do your due diligence and take your time!

Leave a Comment

You must be logged in to leave comments. If you already have an SBA.gov account, Log In to leave your comment.

New users, Register for a new account and join the conversation today!