The average American adult buys a meal or snack from a restaurant 5.8 times per week, and restaurant industry sales are were projected at $783 billion for 2016. With stats like these, it’s no wonder the restaurant business is appealing to so many entrepreneurs. Restaurant franchising, in particular, has become a popular method for individuals to fulfill dreams of business ownership without starting a concept from scratch, but financing a restaurant franchise does have some unique differences.
Restaurant franchises include quick-service restaurants (such as Subway or Dickey’s Barbeque) that account for 72 percent of establishments, and full-service restaurants (such as Applebee’s or Denny’s). As of 2012, there were approximately 1,300 franchised restaurant brands in the U.S. with more than 176,700 locations. In a restaurant franchise agreement, the franchisor licenses use of the brand name and operating methods to you as the franchisee, and you agree to operate according to their standards. You pay a one-time franchise fee for the licensing rights and a continuing fee for ongoing support from the corporate office, which includes marketing, purchasing and systems.
Benefits of starting a restaurant franchise include:
- Built-in name recognition.
- A proven business model.
- Support from the franchisor in helping locate and market the restaurant.
- Purchasing power to lower food and equipment costs.
Unlike financing a restaurant start-up, in which you only have to meet the bank’s requirements, financing a restaurant franchise also requires you to meet the criteria set forth by the franchisor. Here are some tips will help you prepare to meet those requirements to secure your funding.
Franchisor Requirements: Making the Initial Investment
The initial investment to start a restaurant franchise can range from thousands to hundreds of thousands of dollars, depending on the concept you choose. This fee includes not only the upfront rights, but also lease payments, build out costs, equipment purchases, hiring expenses, etc.
To ensure you’re on track to meet the investment amount, some franchisors will require you to have a verifiable net worth or to meet their standard for available personal funds in order to approve you as a franchisee. Some will also want to see a good credit score as proof that you’re financially responsible. Click on the graphs below for a high-level example of the financial requirements of three well-known restaurant franchises: Dickey’s Barbecue Restaurants, Russo’s New York Pizzeria and Tropical Smoothie.
Many of these financial requirements are visible on the franchisor’s website, but you may need to contact the franchise directly or talk to a franchise consultant in order to learn the precise eligibility criteria.
Lender Requirements: Proving Your Business Model
SBA loans are a common method of restaurant franchise financing, which means you’ll also have to meet the lender’s standards to secure funding. Generally, you’ll be expected to put down at least 30 percent of the total cost of the loan and show the lender your franchisor’s business model, which can be found in the Franchise Disclosure Document (FDD).
The FDD is a legal document that outlines various aspects of the franchisor’s business to determine the system’s success. You’ll receive a copy of the FDD during the franchising process and will need to forward that to your lender. They’ll specifically look for:
- Corporate structure
- Business history
- Number of locations
- Growth plans
- Franchise fee structure
- Financial performance
Lenders will also want to examine your own business plan for making the new franchise location successful. While the FDD offers a template for your business plan, you’ll want to dive deeper into the specifics of your location, including your target demographic and what will make your business successful on its own. The lender will probably also consult the Small Business Administration Franchise Registry to gain additional information about the credit risk and default rate associated with the franchise.
It’s particularly important to lenders that you as the owner can demonstrate previous experience in the restaurant industry. Many lenders have seen restaurant loans default because of inexperienced management, so they’re looking for two – five years of upper-level experience to prove you know the ropes of running a restaurant. If you don’t have experience, get some — or be prepared to describe a qualified management team in your business plan and demonstrate your own relevant experience in managing people, operations and budgets.
401(k) Rollovers: An Alternative Restaurant Franchise Financing Option
Aside from traditional bank loans, there are alternative methods that can be used to secure restaurant franchise financing, such as 401(k) rollovers. This approach allows you to leverage funds in an existing retirement account to invest in a franchise without triggering any tax penalties, and there are no credit requirements. In fact, many franchisees use funds from a 401(k) rollover as the down payment on a loan to avoid having to draw from personal savings.
If you team with a solid franchisor with a low default rate, demonstrate your ability to provide the required level of down payment and offer a solid track record of restaurant experience, you’re well on your way to successfully financing your new restaurant franchise. Bon appetit!
