SBA 7(a) Loan for Franchise and Other Financing Options

Introduction

Patrick: Patrick Findaro here, co-founder at Vetted Biz. I’m very excited to have on Al Lesko, who’s a funding strategist at Fund My Franchise. Today we’re going to talk about most popular ways to finance a franchise investment. This includes an SBA 7(a) loan, Small Business Administration loan, 401(k) rollover, as well as a personal loan. So we’re going to go through different ways that you can finance that dream franchise. And, Al, thanks for joining us today.

Al: Hey, thanks for having me. I appreciate the opportunity.

Patrick: It was great connecting at the Franchise Brokers Association Conference in Orlando. I learned a lot just talking to a lot of the franchise brokers, franchisors, as well as just speaking to you on the funding environment. And I thought that you have a lot of knowledge and let’s get that out there and spread the wealth. You’ve done a lot of franchise finance transactions much more open than some of the other funding strategists I’ve spoke to.

Origin of Al’s job

You have many, many different options for financing a franchise, and you’re willing to work with the investor until the end, navigating the bureaucracy at some of these banks and funding firms. So, Al, it’s great to have you on, and maybe first before we go into the different funding options, let me ask. How did you enter in this space, financing franchises?

Al: It’s kind of a unique journey. Actually, I used to work in the auto industry and I worked for a publicly-traded company and in operations. I didn’t like corporate America. I shouldn’t say I didn’t like it, wanted to do my own thing. I’ve always been entrepreneurial. I entered into the franchise industry and I’ve done just about everything in it. But my frustration was what my whole niche is. Which is when I was working with a lot of these funding strategists or funding sources. They were just looking for low-hanging fruit and they weren’t coaching and guiding these clients.

I saw a lot of deals that should have been done that didn’t get done. And I thought this is my opportunity. It made a lot of sense. I enjoy helping people and I enjoy helping people succeed in business. For me, it was just diving in that way.

Patrick: That’s great. Any idea how many people you’ve helped basically fund a franchise investment?

Al: Wow. Right now I’m averaging probably 15 to 20 a month. But then you got to consider I used to be a franchise consultant full-time as well, and, you know, awful lot of deals that way and also as a franchise rep prior. I couldn’t even imagine. I never…

Patrick: We’re talking about the hundreds of cases.

Al: Oh, without a doubt, without a doubt.

Fluctuating business

Patrick: That’s great. I’m sure every client case you work on, it’s kind of learning from the prior one, how to improve it. What’s a better option?

Al: Yeah. Lending is a moving target. Things are changing all the time. I just received a couple of things from the bank that said this is what the new SBA policy is going to be. You have to be adaptive and you have to be in this business full time to be a benefit to your clients.

Patrick: I’ve seen that there are options where you’re dealing directly with a bank or directly with a rollover specialist but that’s all they do. And that might not be the best option for you. It’s great that you can work with the client and you can work with many different banks and see who I guess has the best terms and the best structuring.

Al: Well, you want to put yourself in an advantage, a client should. And to be honest with you, if you’re working directly with a bank, sometimes that’s not in your best interest because the bank has their best interest in mind. You might need somebody in between there that knows what the bank’s rules are, what they’re looking for. And then, of course, what you’re trying to achieve and to put that package together correctly so it works for everybody.

SBA 7 Loan

Parick: Well said. One of the most popular ways to finance a small business investment, acquisition, start up a small business, or even start up a franchise or buy a franchise is through the SBA 7 loan program. And at Vetted Biz we’ve gone through 1.1 million loans of which 100,000 were to franchisees. We get it from the data side but I don’t get it as well from the process and the nuances and the actual deal structuring and making it happen. So, tell us a little bit about the SBA 7(a) loan program as it applies to someone investing in a franchise.

Al:  I think the first thing you start with is, you know, what is the size of the loan? What is the industry of the loan? What do the person’s financials and financial profile look like? And then, of course, you also have to look at the FDD, the franchise itself, and see the strength of that. And then it helps to work with many different banks to know exactly what they’re looking for.

Part of my strategy is to do a full interview with a client that’s seeking an SBA loan and say, where do we want to place him? What type of bank was going to look for this loan? Is this fit the bank’s size of the loan? Because some banks will only do loans that are 350 up. Some banks will only do loans 50,000 to 150,000.

Patrick: And it’s a moving target, right?

Al: Always.

Patrick: You could have a new chief credit officer who just decides overnight, “Hey, we’re not doing this industry anymore”.

Al: Oh, absolutely. And I think that’s the next most important part is knowing the gatekeeper at the bank. You’re going to be dealing with multiple people that make decisions at the bank. And each step in the process should be planned prior to going through the whole process of getting the SBA 7 loan.

Approvals and denials

Patrick: We’ve studied fintechs extensively over the last like three or so years that are in the SBA marketplace. And the reality is they’re not going to more than five banks. They have like five banks and it’s either you do this specific product and this specific industry or they’re not going to work with you. Even the rise, what I’ve seen the rise in technology, especially financial tech, there’s still a relationship thing here where there’s not like a central depository where every credit officer is saying, “I want this loan.” Where you need to have an advisor kind of working with the different banks and the different gatekeepers, as you said.

Al: There’s no substitute for it. In fact, sometimes we’ll have a bank say no when they initially said yes. We’ll simply be in a position to move to another bank that will say yes. You also have some secondary banks that are trying to get preferred lending status with the SBA and they’re hungry. They might be more willing to take on a loan. It’ll take a little longer, they’re not a PLP approved yet but that might be an option where another bank says no.

I think that’s our biggest advantage in what we do at Fund My Franchise is that we go those extra miles. Instead of just saying, “Well, it didn’t go through,” we’re going to work harder. We have options and as long as that client is patient, we’ll find them the loan in most cases.

What Fund my Franchise does

Patrick: Let’s use like a sample case. Someone wants to open up a service franchise. A lot of it it’s going to be the franchise fee, working capital, initial rent deposit. Say all in investment 150k. Could you work with that type of a client that’s not investing in a million but they’re investing closer to 100,000, 200,000?

Al: We do an awful lot of those. In fact, right now they’re very popular to get those SBA loans through at the bank, certain banks that like the smaller size loans. There’s a lot of good reasons for that. You mentioned a service-related business, cash flow is quick. They don’t have to have a brick-and-mortar location. There’s always an audience to buy that industry should the person want to sell it. The bank’s risk is mitigated. Yeah, we like those kind of loans.

Now, what we’ll do with a client is look at that FDD, the franchise disclosure document. We’re going to look at that item seven and see where we can position them to have the best, how do I want to say this? The most amount of liquid capital going into that loan. They’re going to be properly capitalized if not overcapitalized. That’s going to give them a greater chance of success in that particular industry.

We’ll look at where that money is itemized in item seven, and that’s how we’re going to package that loan. Talk about the use of funds. And you mentioned something else that’s very important that the banks look at. That is when you have a very high franchisee because you’re buying may be a territory or whatever, the bank’s going to say, “Well, okay. That might be more of a risk because it’s like, what happens? What do we get if this person defaults?”

Patrick: Yeah. Can you sell that at 25 cents on the dollar, 50 cents on the dollar? Probably some great territories. Yeah.

Al: Exactly.

Analysis of Item 7

Patrick: Say that you’ve gone through the item seven and on the franchise disclosure document the range is anywhere from $80,000 to $150,000. What kind of loan do you see in practice them getting for that type of franchise investment?

Al: Well, what we’ll do is look at the area of the country they’re in and do some demographics. You’re a data guy, I’m a data guy myself. I’m going to say how much money are they going to need? What does that item seven cover? Is it made to just get them in the door? Or, if they’re in a high market or a high dollar market area, we want to make sure we can get them the most we can. Again, the goal being, look, you can get that loan and you can pay that loan back at any time without any prepayment penalty.

Why not get enough or even more extra than trying to shoestring it and get into the business? We’re going to try to coach them on that and say, “You don’t need it, you don’t need it.” You know, I mean, maybe your loan payment’s 100 or 200 bucks higher. But wouldn’t you rather have that security? We do try to make sure that they get enough money.

Patrick: And then is it usually 15% invested capital, 30%? Because I’ve heard different numbers in terms of how much the bank wants to see that you have skin in the game when opening up a franchise.

Al: It’s funny. I kind of make this joke when I’m talking to clients but if you read it, they’ll say 10%. It’s not 10%. On $100,000 loan, you’re required to put in 11.1%, $11,111. At least where I went to school, that’s 11.1%.

Patrick: Exactly.

Collateral costs

Al: They’re also looking that you have some type of liquidity. This is on loans 50 to 150. The loan isn’t secured by collateral like your home or whatever. But it’s actually collateralized by the business assets. They want to make sure that the client isn’t or has some rainy day fund. They’ll want to see 50,000 in either cash, stocks and bonds, IRA or 401(k), something they could liquidate should they get off to a slow start or God forbid a shut down, like COVID, they’ll be able to make their payments.

Patrick: You’re telling me on a franchise, it’s gonna be like a 100k to start up including 4 months of working capital, they could do like potentially 11,000 down. They had 50k in their Charles Schwab or E-Trade account and then they’re getting a loan of say 89,000.

Al: No, they’d actually get a loan for 100,000, the full 100,000. All the bank wants to see is that 11,111 or 11.1% sitting in a business checking account or savings account. And then they want to see that 50,000 in either cash, stocks and bonds, IRA, or 401 in some type of personal account. And the bank will say, “If you have this, your credit and all the other particulars are up to snuff, they’ll grant you the $100,000 loan. Generally, those loans will fund in anywhere from 9 to 12 weeks.

Fund a franchise with a loan

Patrick: Also ,in terms of the cost of one of these SBA 7(a) loans, I understand that by regulation, it can’t be any more than prime plus 2.75. Can you go in a little bit what that actually means for someone that’s trying to get a loan to fund their franchise?

Al: Yeah. If the loan exceeds 150, we like to use a 20-20 rule, which is basically 20% in. In other words, they’re putting it into the business, it’s their money, they’re just showing it, and 20 in reserve. Now, certain industries will be more than that. Like restaurants or gyms will sometimes be 25% in or whatever. The 2.75 the banks are allowed to add to whatever the prime rate is. The prime rate is regulated by the fed. When you see feds raise interest rates, you’ll see that prime rate go up. It’s to Wall Street…

Patrick: And right now does that come out to like 5%?

Al: Six percent right now.

Inflation risk

Patrick: And inflation’s at what? Around 5%, 4.5%?

Al: Yeah. That’s what’s got us worried a little bit. With inflation up, the feds have talked about raising interest rates twice in the next year. You know, you got to kind of think about that. We talked a little bit, an election year is going to affect that. They’re going to try to avoid that as much as they can without letting inflation get out of hand. I think realistically. I think people need to look at it and say what’s going to happen in the next three to five years based on what you’re seeing. And that’s going to be pretty much what your average interest rate is going to be for that term of that loan.

I like to look at it as it’s a 10-year loan. You have to be a little bit political thinking. You got different people changing, whatever, but elections are won by the economy. In a lot of cases, it’s one of the major issues. Keeping that interest rate low, which is a historical low right now is probably going to go up a little bit just based upon current conditions of inflation.

Patrick: Well, even if it goes up a bit, that’s like a cost of 2%. That’s ridiculously cheap capital.

Al: Yeah. I go back and the highest I’ve seen it since I’ve been doing this is 8.5% on loans 150 or less. And that wasn’t all that long ago. We’re talking about five, six years ago. We’re at historically low interest rates and it’s a great time now if you’re going to invest in yourself. I mean, I think there’s 100 reasons why you could think about investing in yourself, making those pros opposed to the cons but you’re not going to get cheaper money. You’re not.