How To Get Franchise Financing With Bad Credit

Mantis Funding October 22, 2024

Securing franchise funding when you have bad credit can feel like an uphill battle, but it’s not impossible. Whether you’ve faced financial setbacks or your credit score simply isn’t where you want it to be, there are still options available to help you achieve your goal of owning a franchise.

In this blog, we’ll explore alternative funding solutions, tips for improving your chances of approval, and how to present a strong case to lenders despite a less-than-ideal credit history. With the right strategy, you can find the financing you need to get your franchise off the ground.

Understanding the Impact of Credit Score on Franchise Financing

Before learning how to secure franchise financing with bad credit, you have to understand what a credit score is, what impacts it, and how your personal credit history comes into play when speaking with franchisors.

Credit Score Definition and Range

A credit score is a numerical representation of your creditworthiness. It ranges from 300 to 850. Lenders use this score to assess how likely you are to repay loans. A score closer to 850 signals strong credit management, while a lower score of around 300 suggests higher risk. This number directly influences your eligibility for loans, interest rates, and even the terms lenders are willing to offer.

Factors Affecting Credit Score

When it comes to understanding your credit score, it’s important to know what factors go into determining it. The key factors that affect your credit score are:

    • Payment History: This makes up 35% of your score and tracks whether you’ve made payments on time. Late or missed payments can significantly lower your score.
    • Credit Utilization: Lenders prefer to see you using less than 30% of your available credit. Higher utilization can signal financial strain.
    • Length of Credit History: The longer you’ve managed credit accounts, the better. A long history shows reliability over time.
    • Credit Mix: A diverse credit portfolio—like a combination of credit cards, loans, and mortgages—can boost your score because it shows you can handle different types of credit.
    • New Credit Inquiries: Applying for too much new credit at once can hurt your score. Lenders may see frequent inquiries as a red flag for financial trouble.

Personal Credit History

Franchisors look at a potential franchisee’s personal credit history as a key indicator of their financial reliability and ability to manage a business. Your credit history reflects how well you’ve handled debt and financial obligations in the past, which can give franchisors confidence in your ability to handle the financial responsibilities of running a franchise. A strong credit history can make you a more appealing candidate, while a lower credit score might raise concerns about your ability to meet financial commitments, secure loans, and manage operational expenses.

Challenges and Opportunities in Franchise Financing with Bad Credit

Securing funding for a franchise with bad credit presents significant challenges because lenders view a low credit score as a red flag for financial risk. Traditional financing options, like bank loans, typically rely heavily on your credit score to determine eligibility, interest rates, and loan terms. With bad credit, you may face higher interest rates, shorter payment periods, or outright denial from lenders. This can make it difficult to gather the capital needed to cover franchise fees, startup costs, and ongoing operational expenses.

However, bad credit doesn’t have to mean the end of your franchise dreams. Alternative funding options, such as working with specialized lenders, seeking out franchisors who offer in-house financing, or exploring revenue-based financing, can provide pathways to securing the funds you need. While these options often come with their own set of risks and higher costs, they can help you overcome the immediate hurdle of bad credit and get your franchise off the ground.

Exploring Funding Options for Franchise Financing with Bad Credit

Although traditional bank loans may not be an ideal option for potential franchisees with low credit scores, there are plenty of other funding options available. We’ve outlined them for you below.

Small Business Administration (SBA) Loans

SBA loans, backed by the U.S. Small Business Administration, offer a way for individuals with bad credit to access traditional financing. The SBA provides a guarantee to lenders, covering a percentage of the loan amount in case of default, which reduces the lender’s risk and makes them more willing to approve loans for borrowers with lower credit scores. However, it’s important to understand that the borrower is still responsible for the full loan amount, even with the SBA’s backing. This guarantee simply encourages lenders to offer more favorable terms.

Alternative Funding Options

For franchisees with bad credit, alternative funding options like revenue-based financing (RBF) can offer a more flexible path to securing capital. RBF allows you to make payments based on a percentage of your business’s future revenue.

Unlike traditional loans that rely heavily on your credit score, RBF focuses more on the potential of your business’s revenue stream, making it a viable option for those with less-than-perfect credit. While other alternatives like crowdfunding or peer-to-peer lending may also be options, revenue-based financing aligns payment with the natural ebbs and flows of your business, giving you more flexibility as you grow your franchise.

For more information on Revenue-Based Financing, read our guide.

Private Lenders

Unlike traditional banks or SBA loans, private lenders often have more flexible terms and are willing to take on higher-risk borrowers. They typically focus more on the overall potential of your franchise, your business plan, and personal assets rather than just your credit score. While the interest rates for private loans can be higher than those for conventional loans, the trade-off is easier approval and faster access to capital. Private lenders also tend to offer more flexible payment options.

Franchisor Financing

Some franchisors offer their own financing programs to help cover essential expenses like franchise fees, equipment, and startup costs. Because the franchisor has a vested interest in your success, these financing options often come with more flexible terms and lower credit requirements. Instead of relying heavily on your credit score, franchisors may focus on your business potential, operational plan, and commitment to the brand. In-house financing simplifies the process by bundling the costs into a single loan and making managing your startup expenses easier.

Crafting a Solid Business Plan

A comprehensive business plan is crucial when seeking franchise financing with bad credit. It shows lenders that you have a clear strategy for success, even if your credit score isn’t ideal. Essentially, it helps offset concerns about your credit by showing lenders that you’re a calculated, capable investment.

Essential Elements of a Business Plan

Your business plan should be professionally worded and presented while reflecting your company’s values. You should include the following components:

    • Executive Summary: A brief overview of your business, including your goals, the franchise you plan to open, and what sets you apart from competitors.
    • Market Analysis: An in-depth look at your target market, competition, and industry trends, showing you’ve done your homework and understand the landscape.
    • Business Structure: A breakdown of your management team, staffing plan, and how the franchise will operate on a daily basis.
    • Marketing and Sales Strategy: Your approach to attracting and retaining customers, including pricing, promotions, and any planned marketing campaigns.
    • Financial Projections: Detailed forecasts of your revenue, expenses, and profit margins over the next few years, demonstrating the financial viability of your franchise.
    • Funding Request: This section outlines exactly how much funding you need, how you’ll use it, and how you plan to repay it.

Startup Plan and Cost Evaluation

Creating a comprehensive startup plan is essential for evaluating the costs of starting a franchise and ensuring you’re financially prepared. This plan should cover everything from one-time expenses to ongoing costs to help you understand your financial needs and avoid surprises down the road. Here’s how to get started:

    1. Franchise Fees: Begin by calculating the initial franchise fee, which grants you the rights to use the brand and business model. This can vary widely depending on the franchise.
    2. Equipment and Inventory: Factor in the costs of equipment, supplies, and initial inventory needed to get the franchise up and running. Be sure to consider maintenance and replacement costs as well.
    3. Location and Build-Out Costs: Evaluate the expenses tied to securing and outfitting a location, including leasing, renovations, signage, and permits.
    4. Working Capital: It’s essential to have working capital to cover initial operating expenses such as payroll, utilities, and rent for the first few months until your franchise starts generating consistent revenue.
    5. Marketing and Advertising: Many franchises have a national marketing fund, but you’ll also need to budget for local advertising and promotions to draw customers to your new business.
    6. Legal and Administrative Fees: Don’t overlook the costs of legal assistance for contracts, accounting services, insurance, and other administrative needs to keep the business compliant and running smoothly.

Lender Considerations and Collateral

Understanding the factors lenders consider and how to use collateral can help you secure more favorable franchise financing.

Factors Lenders Consider

When evaluating a franchise loan application, lenders take several key factors into account to determine your creditworthiness and the potential success of your business, including:

    • Credit History: While it’s not the only factor, your personal and business credit history plays a significant role. Lenders will review your past behavior in managing debt and financial obligations.
    • Business Plan: A detailed and well-structured business plan is crucial. Lenders want to see that you’ve carefully planned out the financial, operational, and marketing aspects of the franchise and that you have a strategy for achieving profitability.
    • Franchise Reputation: The success rate and reputation of the franchise itself can weigh heavily in the decision-making process. Lenders are more likely to approve loans for established franchises with proven business models and strong brand recognition.
    • Collateral: Lenders may require collateral—such as personal or business assets—to secure the loan. This gives them added security in case you default on payments.
    • Cash Flow Projections: Lenders will carefully assess your financial projections, particularly your expected revenue, profit margins, and ability to service the debt. Demonstrating a clear path to profitability can boost your chances of approval.

Experience: Your background in business or relevant industries can also influence the lender’s decision. Experience in running or managing similar businesses can provide additional confidence in your ability to manage the franchise successfully.

Using Collateral to Secure Financing

If you have bad credit, using assets like real estate, stocks, or other investments as collateral can significantly improve your chances of securing financing. Collateral provides lenders with added security, as they can seize these assets if you default on the loan. By offering collateral, you can often negotiate more favorable terms, such as lower interest rates or longer payment periods.

Benefits of Managerial Experience

When seeking financing, having managerial experience can be a major asset in demonstrating your capability to run a franchise successfully. Lenders want to see that you have the skills and knowledge to manage the day-to-day operations of the business, handle staff, and navigate any challenges that arise. Even if your credit isn’t ideal, proven managerial experience can give lenders confidence that you can drive the business to success, making you a more attractive candidate for financing.

Improving Your Credit Score

Even after you’ve secured franchise financing, it’s crucial to continue working on improving your credit score because it can open doors to better loan terms, lower interest rates, and more financial flexibility down the line. Here are some ways you can improve your credit:

  • Pay Bills on Time: Your payment history is the most significant factor in your credit score. Pay all your bills—credit cards, loans, utilities—on time. Even one late payment can have a lasting negative impact.
  • Reduce Credit Utilization: Try to keep your credit card balances lower than your credit limits. Ideally, you should aim to use less than 30% of your available credit to show lenders that you’re not overly reliant on debt.
  • Address Outstanding Debts: If you have any unpaid debts, work on settling them. This can involve negotiating payment plans or paying off smaller balances first to get them off your record.
  • Avoid New Credit Inquiries: Applying for multiple new credit lines in a short period can negatively affect your score. Be selective about any new credit accounts, especially while you’re trying to rebuild.

Securing franchise financing with bad credit can be challenging, but it’s far from impossible. By exploring alternative funding options like revenue-based financing, leveraging personal assets as collateral, and working with franchisors offering in-house financing, you can increase your chances of success. Improving your credit score over time, presenting a solid business plan, and demonstrating your managerial experience will further strengthen your case.

At Mantis Funding, we believe in helping individuals bring their business ideas to life, no matter their financial history. Contact us today to learn how we can help you achieve your dream of franchise ownership.

About Mantis Funding

Mantis Funding is a business financing solutions firm catering to small and mid-sized business owners in the United States.