Franchise Financing with SBA 7a Loans
Using an SBA 7a Loan to Buy a Franchise: Five Key Considerations
For an individual or business looking at purchasing a single or multiple unit franchise, the SBA 7a loan program can be an attractive financing alternative. Women entrepreneurs in particular are frequent borrowers under this program.
The SBA 7a loan program targets small businesses and is one of the most common loan programs available through the SBA. The SBA states that this loan program, “offers flexibility, longer terms and potentially lower down payments compared to other financing options,” which makes it a desirable option for small business owners.
How the SBA Has Evolved Regarding Franchise Acquisition
In recent years, the SBA has worked hard to keep pace with the increasing popularity of franchise ownership. The organization has implemented key changes designed to facilitate the process of opening or buying a franchise using an SBA 7a loan. The SBA announced these changes in October of 2017.
The official notice highlights key ways in which the organization would be changing its policy when handling applicants who intend to use the SBA 7a loan for purchasing or opening a franchise. These policy changes include:
- The development of the SBA Franchise Directory which lists franchises with acceptable franchisor documentation
- The implementation of requirements regarding annual certification from franchisors
- New guidelines regarding document submission to SBA processing centers
- New requirements regarding post-approval documentation prior to the first disbursement of a loan
SBA 7a Loans – Basic Terms
The SBA does not make loans directly. Rather, the SBA provides lenders (banks and others) with a guarantee for a portion of the loan. The maximum loan amount for a 7a loan is $5 million. The maximum SBA guarantee is 85% for loans up to $150,000 and 75% for loans greater in value than $150,000.
The SBA loan program have collateral requirements. Per the SBA, “Lenders are not required to take collateral for loans up to $25,000. For loans in excess of $350,000, the SBA requires that the lender “collateralize the loan to the maximum extent possible up to the loan amount.”
The SBA permits lenders and borrowers to negotiate the interest rates of 7a loans. However, the negotiated rate must not exceed the maximum amount set forth by the SBA. For fiscal year 2019, the SBA has set forth the maximum rates as being:
Loans with a term shorter than 7 years:
Prime + 4.25% for loans between $0 – $25,0000
Prime + 3.25% for loans between $25,001 – $50,000
Prime + 2.25% for loans greater than $50,000
Loans with a term of 7 years or more:
Prime + 4.75% for loans between $0 – $25,000
Prime + 3.75% for loans between $25,0001 – $50,000
Prime +2.75% for loans greater than $50,000
Regarding maturity terms, SBA loans are typically designed with the goal of promoting long-term financial options for small business. The SBA says “Loan maturities are based on the ability to repay, the purpose of the loan proceeds, and the useful life of the assets financed.”
The maximum maturities for SBA 7a loans are:
Business acquisition loans without real estate: 10 years
Working capital or inventory loans: 10 years
Equipment loans: 10 years
Real estate loans: 25 years
Business acquisition loans with real estate: weighted average up to 25 years
Is Your Franchise an SBA Approved Franchise?
As noted earlier, the SBA implemented the SBA Franchise Directory with the goal of streamlining the process of providing potential franchisees with access to capital. In a recent press release about franchise financing, the SBA states that they review franchises and add qualifying organizations to the directory on a regular basis.
This has significantly cut down on loan processing time and has increased efficiency by allowing lenders to process SBA 7a franchise loans without having to further review franchise documents to ensure that they meet SBA requirements.
To determine if your franchise is approved by the SBA, visit the SBA Franchise Directory and search for your franchise. This is an important step in the research process, as only approved franchises are eligible for funding through the SBA.
What Costs Do SBA 7a Loans Cover?
According to the SBA, the 7a loan program provides funding for:
- Startup costs
- Purchasing equipment
- Land or tenant improvement costs
- Franchise fees
- Purchasing an existing business
- Refinancing existing debt
- Purchase supplies or other materials
Opening a New Franchise Location Versus Buying an Existing Franchise Location: Differences in the SBA 7a Loan Program
The process of opening a franchise with an SBA 7a loan differs slightly from buying an existing franchise with a 7a loan. While the spirit of the application process remains largely the same, a key difference between the two relates to the existence of historical financial data. When you purchase an existing franchise, you (and the lender) will have access to information about how the business has historically performed financially.
Such information will allow you to calculate projections for the business’s financial future in a more accurate way than if you were to calculate financial projections without having access to historical data.
A new location will obviously not have historical data regarding performance. This means that when applying for a loan for a new franchise, your business’s financial projections will be more heavily based on input from the franchisor and educated assumptions.
The Importance of Relevant Business Experience for SBA 7a Franchise Financing
As a 7a borrower, it is critical that you have relevant business or management experience when applying for an SBA 7a franchise loan. You should have some experience within your franchise’s particular industry, in addition to experience with running a business and/or managing staff.
Lenders, knowing how important relevant experience is to the SBA, will assess a borrower’s experience when deciding whether or not to approve your loan. This means that prior to seeking an SBA 7a loan for franchise acquisition, you should look for franchises in industries in which you already have experience, or find ways to quickly acquire relevant experience.
Franchisor Support: The Importance of Transition Support for Franchisees
If you are considering acquiring a new or existing franchise, it is important that you look into the support offered by the seller or the franchisor when it comes to the transition of the business.
Transition support typically entails several weeks of training, during which the franchisee has the opportunity to learn about key skills within the franchise itself and the industry as a whole. In addition to an initial training period, some franchisors offer ongoing training opportunities to franchisees.
Such support is important from both a buyer perspective and from the perspective of any lenders involved, as high-quality transition support experiences tend to be correlated with the success of an enterprise.
If you lack direct industry experience, you should focus on buying existing franchise locations where the seller is willing to provide short-term transitional support.
The SBA 7a loan program can be a great financing option for individuals and businesses seeking funds for acquiring an existing franchise or opening a new one.
The SBA exists to support small businesses and to provide them with information, resources, and funding for their ventures. If you are seeking financing for your franchise, the SBA 7a loan program could be the best way for you to realize your entrepreneurial dreams.
Using Dedicated Franchise Financing Through the SBA or Specialty Lenders
Speritas Capital Partners focuses on long term financing for franchise acquisition, to help free-up cash flow, allowing you reinvest and grow your business.
- Up to 90% LTV
- Up to 25 year terms
- Rates starting at 6%
- Fast closings and commitments
- First time owners (some relevant experience required)
- No prepayment penalties
You need a strategic, cost effective solution to your financing needs and a finance advisor you can trust. And one who never takes upfront fees. Let us put our decades of banking and structuring experience to work for you – contact Speritas Capital Partners about franchise financing today.