Franchise ownership often appeals to entrepreneurs who want to run a business with the benefit of an already established brand. But netting funding for your franchise requires a lending partner who shares your commitment and is prepared to help you execute your vision for expansion.
Whether weighing collateral and enterprise value, choosing your ideal loan option or working with a bank to secure funding, knowing your options is essential to focusing on your business and setting yourself up for long-term success.
Here are the three main considerations for business owners when exploring franchise financing.
Rethinking collateral and looking at enterprise value
Franchise financing is specialized lending that is backed by the strength of a franchisor brand. Borrowers can finance a franchise without having to pledge tangible collateral.
Praveen Chathappuram, Senior Vice President and Commercial Banking Division Head at Byline Bank, says while franchisees need to submit cash flow statements, balance sheets and personal guarantees, the collateral piece differs.
“The business doesn’t have physical assets or collateral where there is any value in a liquidation,” he says. “So the value lies in the enterprise value of selling that business or that stream of cash flow to somebody else.”
While a collateral requirement may not fall on your shoulders, in your application you will have to submit paperwork similar to what is required for typical commercial loans. You can expect to provide historical financials that demonstrate steady cash flow. Lenders will typically ask for your EBITDA (earnings before interest, taxes, depreciation and amortization), a financial metric that speaks to a business’s overall health and ability to generate future cash.
At Byline, we take the time to get to know your business. Whether you’d like to improve cash flow, expand operations or update equipment, our team can customize financing and treasury solutions to help. Get in touch.
Banks assess and mitigate risk by considering your business’s enterprise value, which is essentially calculated as a multiple of your EBITDA. Keep in mind, enterprise value also varies by franchise concept. A stronger concept—for instance, one that is known to be easily replicated and consistent in quality—can garner a higher valuation.
Enterprise value gives lenders a full picture of your business’s overall worth, as well as its potential for growth and profitability. Lenders want assurance that your franchise can generate income. But financial obligations can also speak to your company’s overall health, so it’s important that you understand this connection too.
“After determining a franchise’s enterprise value, we have to work through the other factors and then we look at how stable that business is,” Chathappuram says. “If you’re building a new store, for example, can the existing stores carry the debt until the new store is up and running and profitable?”
Choosing your loan
Buying a franchise gives you the opportunity to own your own business while offering you the stability of an established brand. An additional upside is you’re not starting from scratch like you would need to do with a new business.
In fact, a proven track record can benefit you when it comes to seeking financing. Commercial banks tend to prefer lending to franchises with solid performance. Steady cash flow and strong financial metrics — like a high enterprise value — can speak volumes.
Even if a franchise performs well, not all franchises have wide brand recognition, so it’s important to consider your own level of experience as a business owner.
“Some banks may not work with smaller franchises because they may be more regional, haven’t been around long enough to determine risk, or the corporate company isn’t as strong when it comes to supporting the franchisees,” says Adnan Assad, Senior Vice President and Commercial Banking Division Head at Byline Bank.
Conventional financing can be a good fit if your franchise is a well-known brand, but a Small Business Administration (SBA) loan may be a more viable option if you have a shorter track record or your franchise has a lower enterprise value.
Working with a bank to support your goals
Being a franchise owner doesn’t mean your business is a one-size-fits-all entity. Your funding needs are as unique as your goals, so finding a commercial lender to support your business now and in the future as a true partner is essential.
“You want to avoid working with any financial institution that puts you in a box with franchise lending,” says Chathappuram. “Your risk profile and needs are different depending on factors such as whether you own one store or 100 stores.”
Imagine you own five stores, and construction is happening on the street in front of one of your franchise locations. Sales will be disrupted, but the effect across your entire business likely will be lower compared to a franchisee who owns only one store located on the same street undergoing construction.
Assad notes that smaller operators tend to face higher costs to run their stores compared to those who own more and can take advantage of economies of scale.
“The more stores a franchisee has, the more each of them helps the other,” he says.
An experienced commercial lending professional should be able to support your current and future business operations by understanding the nuances your operations face in terms of risk and sales. Ultimately, you want to work with a lender that truly understands your specialized needs within the franchise world and sets you up for growth.
“A true banking partner will structure the credit facilities to create a custom solution. Needs are different from one franchise owner to another,” says Chathappuram. “You want a lender who understands the franchise world and has a deep knowledge of your business, so they can keep you abreast of the reality of how your business needs to grow.”
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